8
Operating Assets
Property, Plant, and
Equipment, and
Intangibles
PowerPoint Author: Catherine Lumbattis
COPYRIGHT © 2011 South-Western/Cengage Learning
Nike, Inc.
Property, Plant, and
Equipment
(in millions)
Land
Buildings
Machinery and equipment
Leasehold improvements
Construction in progress
Less accumulated depreciation
Property, plant, and equipment (net)
$
At
Cost
209.4
934.6
2,005.0
757.3
196.7
$ 4,103.0
(2,211.9)
$ 1,891.1
Book Value
LO 1
Acquisition Cost of PP&E
All costs necessary to acquire asset and
prepare for intended use
Examples:
Purchase price
Purchase
Taxes paid at time of purchase
Price
+ Transportation charges
Taxes
Installation Costs
LO 2
Group Asset Purchases
Allocate cost of lump-sum purchase based on fair market values
Fair Market
Value
% of
Market
Value
Cost
Allocated
Cost
Building =
$90,000
75% X
$100,000 =
$75,000
Land =
$30,000
25% X
$100,000 =
$25,000
LO 3
Capitalization of Interest
Interest can be included as part of the cost of
an asset if:
• company constructs asset over time, and
• borrows money to finance construction
5
Land Improvements
Land improvements with a limited life should
be kept separate from the land since:
• Land improvements that have a limited life would
be subject to depreciation over the useful life of the
improvement
• Land has an unlimited life and therefore is not
subject to depreciation
6
Depreciation of PP&E
Match
costs of
assets
With
periods
benefited
via
Straight-Line
Units of
Production
Accelerated
Methods
LO 5
Straight-Line Method
 Allocates cost of asset evenly over its useful life
$9,000
3-year life
$3,000
Year 1
$3,000
Year 2
$3,000
Year 3
Units-of-Production Method
Allocate asset cost based on number of units
produced over its useful life
Depreciation =
$ per unit
Double-Declining-Balance
Method
Double the straight-line rate on a declining balance (book
value)
Accelerated method - higher amount of depreciation in
early years
Straight-line
Rate
Depreciation Example
On January 1, 2010, ExerCo purchases
a machine for $20,000. The life of the
machine is estimated at five years, after
which it is expected to be sold for $2,000.
Depreciation Example
Calculate ExerCo’s depreciation of the
machine for 2010–2014 using the
units-of-production and double-decliningbalance depreciation methods.
$20,000 cost – $2,000 residual value =
$18,000 to be depreciated
Straight-Line Depreciation
Depreciation = Cost – Residual Value
Life
$18,000
5-year life
$3,600
2010
$3,600
2011
= $20,000 – $2,000
5 years
=
$3,600
2012
$3,600/year
$3,600
2013
$3,600
2014
Units-of-Production
Depreciation
ExerCo’s
estimated machine production:
2010
2011
2012
2013
2014
Total
3,600 units
3,600 units
3,600 units
3,600 units
3,600 units
18,000 units
Units-of-Production
Depreciation
Depreciation = Cost - Residual Value
per unit
Life in Units
= $20,000 – $2,000
18,000
= $ 1.00 per unit
Units-of-Production
Depreciation

ExerCo’s depreciation in 2010:
4,000 units x $1/unit = $ 4,000
Double-Declining-Balance
Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 5 years) x 2
= 40%
Initially
ignore
residual value
Double-Declining-Balance
Depreciation
2010 Depreciation = Beginning book value x rate
=
$20,000
x 40%
=
$8,000
Year
2010
Rate
40%
Beginning
Ending
Book Value Depreciation Book Value
$20,000
$8,000
$12,000
Double-Declining-Balance
Depreciation
2008 Depreciation = Beginning Book Value × Rate
= $12,000 × 40%
= $4,800
Beginning
Year Rate Book Value
2008 40% $20,000
2009 40% $12,000
Depreciation
$8,000
$4,800
Ending
Book Value
$12,000
$ 7,200
Double Declining-Balance
Depreciation
Year
2010
2011
2012
2013
2014
Rate
40%
40%
40%
40%
40%
Beginning
Ending
Book Value Depreciation Book Value
$20,000
$8,000
$12,000
12,000
4,800
7,200
7,200
2,880
4,320
4,320
1,728
2,592
2,592
592
2,000
$18,000
Final year’s depreciation =
amount needed to equate book
value with salvage value
= Residual
Value
Straight-line vs. DDB Depreciation
2010
2011
2012
2013
2014
21
Reasons for Choosing
Straight-Line Depreciation
 Simplicity
 Reporting to stockholders
 Comparability
 Bonus plans
Reasons for Choosing
Accelerated Methods
Technological rate of
change and competitiveness
Minimize taxable income
Comparability
Changes in Depreciation
Estimates
Recompute depreciation schedule
using new estimates
Record prospectively (i.e., change
should affect current and future
years only)
LO 6
Change in Estimate
Example:
$20,000 machine originally expected to be depreciated over
5 years. After 2 years, useful life is increased to 7 years.
$3,600
$3,600
planned
$3,600
2008
2009
2010
Depreciation
revise
estimate
2011
2012
Change in Estimate
Example:
$10,800 ($12,800 remaining book value – $2,000
salvage) allocated over remaining life
$3,600
$3,600
$2,160
$2,160
$2,160
$2,160 $2,160
2008
2009
2010
2011
2012
2013
revise
estimate
Depreciation
2014
Capital vs. Revenue
Expenditures
Capital Expenditure
• Treat as asset addition to
be depreciated over a
period of time
Revenue Expenditure
• Expense immediately
Balance
Sheet
Income
Statement
LO 7
Capital vs. Revenue
Expenditures
Category
Normal maintenance
Minor repair
Major repair
Addition
Example
Repainting
Replace spark plugs
Replace a vehicle’s
engine
Add a wing to a
building
Asset or Expense
Expense
Expense
Asset*
Asset
*if life or productivity is enhanced
28
Capital Expenditures
Example:
A $20,000 machine purchased on January 1, 2010 is originally
expected to be depreciated over 5 years. After 2 years, an
overhaul of the machine is made at a cost of $3,000. Machine
life is increased by 3 years.
$3,600
$3,600
planned
$3,600
2010
2011
2012
replace
engine
2013
2014
Capital Expenditures
Example:
$12,800 remaining book value + $3,000 capital
expenditure depreciated prospectively over
remaining life
$3,600
$3,600
$2,300
$2,300
$2,300
$2,300 $2,300
2008
2009
2010
2011
2012
2013
replace
engine
2014
Disposal of Operating Assets
 Record depreciation up to date of disposal
 Compute gain or loss on disposal
Proceeds > Book Value = Gain
Proceeds < Book Value = Loss
LO 8
Disposal of Operating Assets
Example:
Sell truck (cost $20,000; accumulated depreciation
$9,000) for $12,400
Sale price
Less book value:
Asset cost
Less: accumulated
depreciation
Gain on sale
$ 12,400
$20,000
9,000
( 11,000)
$ 1,400
Disposal of Operating Assets
Example:
Sell truck (cost $20,000; accumulated depreciation
$9,000) for $10,000
Sale price
Less book value:
Asset cost
Less: accumulated
depreciation
Loss on sale
$ 10,000
$20,000
9,000
( 11,000)
$ 1,000
Gain/Loss on Sale of
Operating Asset
Gain or Loss on Sale of Operating Asset
appears on the Income Statement
 Gain or Loss on Sale of Operating Asset is
reported as Other Income/Expense since
it does not constitute the company’s
ongoing or central activity

IFRS and Property, Plant, and
Equipment
There are two important differences between U.S.
GAAP and International Accounting Standards (IFRS):
IFRS requires estimates of residual value and the life of the
asset be reviewed at least annually. FASB standards does
not require the annual review.
International Standards allow (but do not require)
companies to revalue these assets to reflect their
fair market values. FASB does not allow this revaluing to
fair market value.
Intangible Assets
Long-term assets with no physical properties
Patents
Copyrights
Trademarks
Goodwill
LO 9
Intangible Assets
 Includes cost to acquire and
prepare for
intended use
Purchase
Price
+
Acquisition Cost
(i.e., legal fees,
registration fees,
etc.)
+
Nike, Inc.
Partial Balance Sheet
(in millions)
Amortized Intangible Assets:
Patents
Trademarks
Other
2008
$ 33.1
5.4
45.5
$ 84.0
Unamortized intangible assets:
Trademarks
Total
$659.1
$743.1
???? Typo
in text???? Exhibit 8-4 doesn’t make sense
38
Research & Development
Must be expensed in period incurred
Difficult to identify future benefits
Amortization of Intangibles
Normally recorded using straight-line method
Reported net of accumulated amortization
Amortized over legal or useful life, whichever is
shorter
LO 10
Amortization of Intangibles
Example:
Nike developed a patent for $10,000.
The patent’s legal life is 20 years, but
its anticipated useful life is 5 years.
Amortization of Intangibles
Journal entry:
Patent Amortization Expense
2,000
Accumulated Amortization—Patent
2,000
To record amortization of patent for one year.
Nike’s annual amortization:
Patent approval costs
Divided by:
Lesser of legal or useful life
Annual amortization
$10,000
5 years
$ 2,000
Intangibles with Indefinite Life
Amortization is not recognized on an asset with
an indefinite life.
e.g., Trademarks, goodwill and broadcast
licenses
For intangibles with indefinite lives, impairment
of these assets must be considered.
If an impairment has occurred, a loss should be
recognized
IFRS and Intangible Assets
International Standards are more flexible in
allowing the use of market values for intangible
assets for those assets with an “active market”
FASB requires all research and development
costs be treated as an expense while
International Standards require research cost be
expensed and development costs can be
capitalized if certain criteria are met
Long-term Assets and
the Statement of Cash Flows
Operating Activities
Net income
Depreciation and amortization
Gain on sale of asset
Loss on sale of asset
Investing Activities
Purchase of asset
Sale of asset
Financing Activities
xxx
+
+
+
LO 11
Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation Expense
What is the average
depreciable period (or life) of
the company’s assets?
LO 12
Analyzing Long-term Assets
Average Age = Accumulated Depreciation
Depreciation Expense
Are assets old or
new?
Analyzing Long-term Assets
Asset Turnover =
Net Sales
Average Total Assets
How productive
are the company’s
assets?
End of Chapter 8