©2009 The McGraw-Hill Companies, Inc.
Chapter 7
Long-Term Assets
7-2
Categories of Long-Term Assets
Property, Plant
and Equipment
Intangible Assets
Land, land improvements,
buildings, equipment,
and natural resources
Patents, trademarks,
copyrights, franchises, and
goodwill
Physical substance
Lacks physical substance
©2009 The McGraw-Hill Companies, Inc.
Part A
Acquisition and Improvements
7-4
LO1 Property, Plant and Equipment

Record a long-term asset at
Cost
+
All expenditures necessary to
get the asset ready for use
7-5
Land and Land Improvements
Land represents property a company is using in its operations
We capitalize to land all expenditures necessary to get the land ready for its
intended use.
Capitalized costs include the purchase price of the land plus:

closing costs such as attorney fees

real estate commissions

title

title search

recording fees

clearing, filling, and draining the land

removing old buildings to prepare the land for its intended use
Any additional amount spent to improve the land by adding a parking
lot, paving, temporary landscaping, lighting systems, fences,
sprinkler systems etc. are recorded separately as land
improvements, which are subject to depreciation.
7-6
Buildings
Buildings include offices, retail stores, storage warehouses, and
manufacturing facilities a company is using in its operations.
The cost of acquiring a building usually includes:
 the purchase price
 realtor commissions
 legal fees
 other costs incurred to remodel the building
The cost of constructing a building usually includes:
 architect fees
 material costs
 construction labor
 officer supervision
 overhead (costs indirectly related to the construction) and
“capitalized interest” (refers to interest costs we add to the asset
account rather than recording them as interest expense.)
7-7
Equipment
Includes machinery used in manufacturing, computers and other
office equipment, vehicles, furniture, and fixtures.
The cost of equipment includes:
 actual purchase price
 sales tax
 shipping
 delivery insurance
 assembly, installation and testing
 legal fees incurred to establish title.
Rather than including recurring costs, such as insurance
and property taxes, as part of the cost of the equipment, we
expense them as we incur them in order to properly match
them with revenues.
7-8
Natural Resources
Oil, Natural Gas, and Timber
We can physically use up, or deplete,
natural resources.
For example, Exxon Mobil’s oil reserves
are a natural resource that decreases as
the firm extracts oil.
7-9
LO2 Intangible Assets
Companies can either purchase or create intangible assets internally.

Purchase intangible assets
like patents, copyrights,
trademarks, or franchise
rights from other entities.

Create intangible assets
internally through research
and development or
advertising.

Record purchased intangible
assets at their original cost
plus all other costs, such as
legal and filing fees,
necessary to get the asset
ready for use.

Rather than recording these
as an intangible asset on the
balance sheet, expense most
of the costs for internally
developed intangible assets
to the income statement as
they are incurred.
For example, research and
development costs,
advertising costs.
7-10
Patents
An exclusive right to manufacture a product or to use a
process (normally granted for a period of 20 years).
The cost of a patent includes:
When it is purchased
 purchase price
 legal and filing fees to secure the patent
 any attorney fees and other costs of successfully defending
the patent in court
When it is internally developed
 research and development costs (expensed as incurred)
 legal and filing fees to secure the patent (recorded in the
patent asset account)
7-11
Copyrights
An exclusive right of protection given to the creator of a
published work such as a song, film, painting, photograph,
book, or computer software.



Protected by law
Gives the creator (and his or her heirs) the exclusive
right to reproduce and sell the work for the life of the
creator plus 70 years
Accounting for the costs of copyrights is virtually
identical to that of patents
7-12
Trademarks
A word, slogan, or symbol that distinctively identifies a company,
product, or service.




Can be registered for a period of 10 years. Registration can be
renewed for an indefinite number of 10-year periods (useful life
can be indefinite).
Firms often acquire trademarks through acquisition.
When a firm develops a trademark internally through advertising,
it records the advertising costs as expenses in the income
statement.
The firm can record attorney fees, registration fees, design
costs, successful legal defense, and other costs directly related
to securing the trademark as an intangible asset in the
trademark asset account.
7-13
Franchises
Local outlets that pay for the exclusive right to use the
franchisor company’s name and to sell its products within
a specified geographical area.



Many franchisors provide other benefits to the
franchisee, such as participating in the construction of
the retail outlet, training employees, and purchasing
national advertising.
The franchisee records the initial fee as an intangible
asset and then expenses it over the life of the franchise
agreement.
Additional periodic payments by the franchisee usually
are for services the franchisor provides on a continuing
basis. These are expensed by the franchisee as
incurred.
7-14
Goodwill
Represents the value of a company as a whole, over and
above the value of its identifiable net assets.


Recorded as an intangible asset in the balance sheet only
when purchased as part of the acquisition of another
company.
Goodwill is equal to the purchase price minus the fair
value of the net assets acquired.
7-15
LO3 Expenditures after Acquisition
Capitalize as an
asset if it
increases future
benefits
Expenditures
after Acquisition
Expense if it
benefits only the
current period
Repairs and maintenance, additions, improvements, or
litigation costs
7-16
Repairs and Maintenance
Expensed if repairs
maintain a given level of
benefits in the period
incurred
Capitalize as assets more
extensive repairs that
increase future benefits
For a delivery truck
EXPENSE
CAPITALIZE
Cost of an engine tune-up or the
repair of an engine part
Cost of a new transmission or an
engine overhaul
7-17
Additions
Occurs when we add a new major component to an
existing asset
CAPITALIZE
the cost of additions because
they increase, rather than
maintain, the future benefits from
the expenditure
DEPRECIATE
the capitalized cost over the
remaining useful life of the
original asset or the addition,
whichever is shorter.
7-18
Improvements
The cost of replacing a major component of an asset.
A new component
with the same
characteristics as
the old component
CAPITALIZE
A new component
with enhanced
operating
capabilities
Replace an existing refrigeration unit in a delivery truck
With a new but
similar unit
With a new and
improved
refrigeration
unit
7-19
Legal Defense of Intangible assets
The cost of legally defending the right that gives the
asset its value.
If the defense of an intangible right is
Successful
Unsuccessful
CAPITALIZE
EXPENSE
litigation costs and amortize them
over the remaining useful life of
the related intangible
the litigation costs as incurred
because they provide no future
benefit
©2009 The McGraw-Hill Companies, Inc.
Part B
Cost Allocation
7-21
LO4 Depreciation of Tangible Assets
Dictionary definition = Decrease in value.
Accounting definition = Allocation of an asset’s cost
Cost incurred to purchase
an asset (future benefit)
Depreciation = Allocation of a portion of the
asset’s cost to an expense over all periods
benefited.
$Cost
$Benefit
$Benefit
Time Periods
$Benefit
$Benefit
7-22
Depreciation Example
Starbucks pays $1,200 for a computer expected to have value for
four years and allocates the cost equally over the years in that
period. The entry to record annual depreciation is:
Depreciation Expense
300
Accumulated Depreciation
300
(To record depreciation = $1,200 / 4 years)
Rather than credit the equipment
account directly, we instead credit
its contra account i.e. Accumulated
Depreciation which is then offset
against the equipment account in
the balance sheet.
After one year, we have
Equipment (cost)
Less: Accumulated depreciation
($300 x 1 year)
= Book value
$1,200
(300)
$ 900
7-23
Depreciation Terminology




Accumulated depreciation is a contra-asset account
representing the total depreciation taken to date.
Book value is equal to the original cost of the asset minus
the current balance in accumulated depreciation.
Service life (or useful life) is how long the company
expects to receive benefits from the asset before disposing
of it; can be measured in units of time or in units of activity.
Residual value (or salvage value) is the amount the
company expects to receive from selling the asset at the
end of its service life.
7-24
Depreciation of Tangible Assets
Depreciation
No Depreciation
Equipment
Land
Improvements
Buildings
Land
7-25
Depreciation Methods
Depreciation Methods
Straight-line
Declining-balance
Activity-based
7-26
Straight-Line Depreciation
Allocates an equal amount of the allocation base to each
year of the asset’s service life
Straight-Line
Depreciation
Asset cost - Estimated residual value
=
Asset’s service life
7-27
Declining-Balance Depreciation




An accelerated depreciation method
Will be higher than straight-line depreciation in
earlier years, but lower in later years
Both declining-balance and straight-line will result
in the same total depreciation over the asset’s
service life
The most common declining-balance rate is
200%, which we refer to as the double-decliningbalance method since the rate is double the
straight-line rate
7-28
Activity-Based Depreciation
Allocate an asset’s cost based on use rather than time
Step 1
Compute the average depreciation rate per unit
Asset cost - residual value
Units expected to be produced
Step 2
Multiply the average depreciation rate per unit by the
number of units each period
7-29
Tax Depreciation



An accelerated method that reduces taxable
income more in the earlier years of an asset’s life
than straight-line.
Most companies use the straight-line method for
financial reporting and an accelerated method
called MACRS for tax reporting.
Thus, companies record higher net income using
straight-line depreciation and lower taxable
income using MACRS depreciation.
7-30
LO5 Amortization of Intangible Assets
Allocation of the cost of intangible assets
Intangible assets
subject to amortization
Assets having a finite
useful life that we can
estimate
Patents, Copyrights, Franchises
Intangible assets not
subject to amortization
Assets having
indefinite useful lives
Goodwill, Trademarks
7-31
Amortization of Intangible Assets



Estimate the intangible asset’s service life (usually
is limited by legal, regulatory, or contractual
provisions)
Estimate its residual value (for most intangible
assets, it is zero)
Allocate the asset’s cost less any estimated
residual value to periods in which we expect the
intangible asset to contribute to the company’s
revenue-generating activities.
7-32
Amortization Example
In early January, Little King Sandwiches acquires franchise rights from University Hero
for $800,000. The franchise agreement is for a period of 20 years. In addition, Little
King purchases a patent for $72,000. The original legal life of the patent was 20 years;
there are 12 years remaining. However, due to expected technological obsolescence,
the company estimates that the useful life of the patent is only 8 more years. Little
King uses straight-line amortization for all intangible assets. The company’s fiscal
year-end is December 31.
The amortization expense for the franchise and the patent is recorded as:
Amortization Expense
40,000
Franchise
40,000
(Amortization expense = $800,000 / 20 years)
Amortization Expense
Patent
(Amortization expense = $72,000 / 8 years)
9,000
9,000
7-33
Intangible Assets not subject to
Amortization



Do not amortize intangible assets with indefinite useful lives.
Goodwill is the most common intangible asset with an
indefinite useful life. Another example is trademarks.
Review these assets for a potential write-down when events
or changes in circumstances indicate the amount recorded
in the accounting records might not be recoverable.
©2009 The McGraw-Hill Companies, Inc.
Part C
Asset Disposition
7-35
LO6 Disposal of Long-Term Assets
Disposal of Long-Term Assets
Sale
Can result in either a
gain or a loss
Retirement
Occurs when a longterm asset is no
longer useful but
cannot be sold
Exchange
Occurs when two
companies trade
assets
7-36
Recording Long-Term Asset
Disposals
Little King Sandwiches purchased a new delivery truck.
Here are the specific details:
Cost of the new truck
$40,000
Estimated residual value
$5,000
Estimated service life
5 years
7-37
Sale
If we assume that Little King sells the delivery truck at the end of year 3 for
$22,000, we can calculate the gain as $3,000. Note that both the delivery truck
and the related accumulated depreciation account are removed.
Sale amount
$22,000
Less:
Cost of the new truck
$40,000
Less: Accumulated depreciation
(3 years x $7,000/year)
(21,000)
Book value at the end of year 3
19,000
Gain on sale
$3,000
The entry to record the gain on sale is:
Cash
22,000
Accumulated Depreciation
21,000
Delivery Truck
Gain on sale
(To record gain on sale)
40,000
3,000
7-38
Retirement
If we assume that the delivery truck is totaled in an accident at the end
of year 3, we have a $19,000 loss on retirement.
Sale amount
$0
Less:
Cost of the new truck
$40,000
Less: Accumulated depreciation
(3 years x $7,000/year)
(21,000)
Book value at the end of year 3
19,000
Loss on retirement
($19,000)
The entry to record the loss on retirement is:
Accumulated Depreciation
21,000
Loss on Retirement
19,000
Delivery Truck
(To record loss on retirement)
40,000
7-39
Exchange
Assume that Little King exchanges the delivery truck at the end of year 3 for a
new truck valued at $45,000. The dealership gives Little King a trade-in
allowance of $23,000 on the exchange, with the remaining $22,000 payable in
cash. We have a $4,000 gain.
Trade-in allowance
$23,000
Less:
Cost of the new truck
$40,000
Less: Accumulated depreciation (3 years x $7,000/year)
(21,000)
Book value at the end of year 3
19,000
Gain on exchange
$4,000
The entry to record the gain on exchange is:
Delivery Truck (new)
45,000
Accumulated Depreciation
21,000
Cash
22,000
Delivery Truck (old)
40,000
Gain on Exchange
4,000
(To record gain on exchange)
7-40
LO7 Asset Analysis
Analyze the relation between Return on Assets, Profit Margin and Asset
Turnover to analyze the profitability of a company’s assets.
Return on Assets
=
Net Income
Average Total
Assets
Profit Margin
x
Net Income
=
Net Sales
Asset Turnover
Net Sales
x
Average Total
Assets
To maximize profitability, a company ideally strives to increase
both net income per dollar of sales (profit margin) and sales per
dollar of assets invested (asset turnover).
©2009 The McGraw-Hill Companies, Inc.
Appendix
Asset Impairment
7-42
Asset Impairment
Impairment occurs when the future cash flows (future benefits)
generated for a long-term asset is < its book value (cost minus
accumulated depreciation)
Impairment loss = Asset’s book value - its fair value.
STEP 1:
Test for Impairment
Are future cash flows less than book
value?
Yes
Asset Impaired
STEP 2:
If Impaired, Record Loss
Record Loss
(Loss equals
book value of
asset in excess of
fair value of
asset)
No
Asset Not
Impaired
No Action Needed
©2009 The McGraw-Hill Companies, Inc.
End of chapter 7