Chapter 9
Investments in Property, Plant,
and Equipment and in
Intangible Assets
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
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Long-Term Assets
• Property, plant, and equipment
– Tangible assets acquired for the use in
business operations.
– Land, buildings, and equipment.
• Intangible Assets
– Assets without physical substance that are
used in business.
– Licenses, patents, franchises, and goodwill.
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Capital Budgeting
• Capital budgeting
– Planning for investment in long-term assets.
– Long-term assets have value because they
help companies generate future cash flows.
– Involves comparing the cost of the asset to
the value of the expected cash flows, after
adjusting for the time value of money.
• Time value of money
– The concept that a dollar today is worth more
than a dollar received in the future.
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Asset Acquisition
• Include purchase price.
• Include costs incurred to acquire the asset
and getting it ready for its intended use.
– Sales tax, shipping, installation, and other
costs.
Fork Lift. . . . . . . . . . . . . . . . . . . . . . . .
Cash. . . . . . . . . . . . . . . . . . . . . . . .
Notes Payable. . . . . . . . . . . . . . . .
12,500
3,500
9,000
Purchased a fork lift for $12,000 and paid $500 for
shipping; paid $3,500 cash and issued a note for
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$9,000 to the bank.
Leases
• Lease
– A contract that specifies the terms under
which the owner of an asset (the lessor)
agrees to transfer the right to use the asset to
another party (the lessee).
– What terms should be included in a lease?
• Term
• Payment amount
• Due dates
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Match Lease Terms
Capital
Lease
Lessor
Operating
Lease
Lessee
•The party that is granted the
right to use the property under
the terms of a lease.
•The owner of property that is
leased (rented) to another party.
•A simple rental agreement.
•A leasing transaction that is
recorded as a purchase by the
lessee.
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Classifying Leases
•
A lease is classified as a capital lease if it
is non-cancelable and meets one of the
following criteria:
1. Lease transfers ownership of the asset.
2. Lease contains a bargain purchase option.
3. Lease term is equal to 75% or more of the
estimated life of the asset.
4. Present value of the lease payments is
equal to 90% or more of the fair market
value of the asset.
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Operating Lease
Dahl & Sons, Attorneys at Law, leases a building
with monthly rental payments of $1,000. Make the
appropriate entry if rent is paid in cash the first
month.
Rent (or Lease) Expense . . . . . . . . . .1,000
Cash. . . . . . . . . . . . . . . . . . . . . . . .
1,000
To record monthly rent of storage building.
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Capital Lease
Dahl & Sons enters into a non-cancelable lease agreement
that requires lease payments of $100,000 a year for 20 years.
At the end of 20 years, Dahl & Sons will own the property. The
present value of the lease payments at a 10% discount rate is
$851,360. Make the appropriate entries.
Leased Property. . . . . . . . . . . . . . . . 851,360
Lease Liability. . . . . . . . . . . . . . . .
851,360
To record commercial building acquired under a
20-year non-cancelable lease.
Lease Liability. . . . . . . . . . . . . . . . . . 14,864
Interest Expense. . . . . . . . . . . . . . . . 85,136
Cash. . . . . . . . . . . . . . . . . . . . . . . .
100,000
To record annual payment under capital lease.
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Assets Acquired by
Self Construction
• Self-constructed assets
– Recorded at cost.
– Include all expenditures incurred to build the asset
and make it ready for its intended use.
• Costs include:
–
–
–
–
Materials used to build the asset.
The construction labor.
Capitalized interest.
Some reasonable share of the general company
overhead.
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Basket Purchases
When two or more assets are acquired at a single price, the
prices are allocated on the “relative fair market value” method.
In this example, Dahl and Sons purchased land and a building
at a total cost of $3,600,000. Prepare the entry to record the
purchase.
Asset
FMV
Land
$1,000,000
Building 3,000,000
Total
$4,000,000
% of Total
Value
25%
75
100%
Cost
0.25 x $3,600,000 = $ 900,000
0.75 x $3,600,000 = 2,700,000
$3,600,000
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . 900,000
Building. . . . . . . . . . . . . . . . . . . . . . . . 2,700,000
Cash. . . . . . . . . . . . . . . . . . . . . . . .
3,600,000
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To record building and land acquired for $3,600,000.
Depreciation
• Depreciation
– The process of cost allocation that assigns
the original cost of plant and equipment to the
periods benefited.
• Book value
– The assets original cost less any accumulated
depreciation.
• Salvage value
– The amount expected to be received when
the asset is sold at the end of its useful life.
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Straight-Line Depreciation
• Costs assigned equally to all periods benefited.
Annual
Depreciation
Expense
$5,500
=
Cost - Salvage value
Estimated useful
life (years)
=
$24,000 - $2,000
4 years
Depreciation Expense. . . . . . . . . . . . . . . . . 5,500
Accumulated Depreciation. . . . . . . . . . .
5,500
To record annual depreciation for truck.
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Units-of-Production Depreciation
• Assigning depreciation according to what has
been used during the year.
Per Unit
Depreciation
Depreciation
Expense
$4,400
=
Cost - Salvage value
Estimated life in units
=
Per unit
depreciation x
=
($24,000 - $2,000)
60,000 miles
Units
produced
x 12,000
miles
Depreciation Expense. . . . . . . . . . . . . . . . . 4,400
Accumulated Depreciation. . . . . . . . . . .
4,400
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To record annual depreciation for truck.
Partial-Year Depreciation
• Straight-line method
– Calculate depreciation expense for the year.
– Distribute it evenly over the number of months
the asset is held during the year.
• Units-of-production method
– The same as normal because it is based off of
the actual usage.
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Repairing and Improving Assets
• Ordinary expenditures
– Typically benefit only the period in which they are
made.
– (i.e. repairs, maintenance, and minor improvements.)
– Expense when incurred.
• Capital expenditures
– Significant in amount and benefit more than the
current period.
– Increase the productive life or capacity of the asset.
– (i.e. engine overhaul, components added.)
– Capitalize and add to asset value.
– Depreciated over the remaining life of the asset.
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Discarding and Selling LongTerm Assets
• An asset’s cost and accumulated
depreciation must be removed from the
accounting records.
• Assets can be:
– Discarded (scrapped)
– Sold
– Exchanged
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Discarding Property, Plant, and
Equipment
Dahl & Sons purchased an advance copier system for $15,000.
It has a 5-year life, no salvage value, and is depreciated on a
straight-line basis. If Frank pays $300 to have the copier
removed, what is the appropriate entry?
Accumulated Depreciation, Conveyor . . . 15,000
Loss on Disposal of Conveyor . . . . . . . . .
300
Conveyor. . . . . . . . . . . . . . . . . . . . . . . .
15,000
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . .
300
Scrapped $15,000 copier and paid $300 disposal
costs.
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Selling Property, Plant, and
Equipment
Dahl & Sons purchased an advanced copier system for
$15,000. It has a 5-year life, no salvage value, and is
depreciated on a straight-line basis. If the copier is sold for
$600 after only four years of service, Dahl & Sons will
experience a loss of $2,400. Make the appropriate entry.
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
600
Accumulated Depreciation, Conveyor . . . 12,000
Loss on Sale of Conveyor. . . . . . . . . . . . .
2,400
Conveyor. . . . . . . . . . . . . . . . . . . . . . . . .
15,000
Sold $15,000 copier at a loss of $2,400.
Losses are incurred when the asset is sold for less than the
book value and gains are recorded when the asset is sold for
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more than the book value.
Accounting for Intangibles
• Intangibles
– Rights and privileges that are:
•
•
•
•
Long-lived.
Not held for resale.
Have no physical substance.
Providing owner with competitive advantage over other
firms.
• Amortization
– Periodic allocation to expense of an intangible
asset’s cost.
– Conceptually, the same as depreciation.
– Intangible assets generally use straight-line
amortization.
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Types of Intangibles
• Patent
– An exclusive right granted for 17 years by the U.S.
Federal Government to manufacture and sell an
invention.
• Franchise
– An entity that has been licensed to sell the product of
a manufacturer or to offer a particular service in a
given area.
• License
– The right to perform certain activities, generally
granted by a government agency.
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Recognizing Intangible Assets
• Intangible assets are only recognized in
the financial statements if they have been
purchased.
• Amortize over the economic life of the
intangible asset.
• Intangible assets with indefinite lives are
not amortized.
• Intangible assets must be analyzed to
determine if impairment has occurred.
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Goodwill
• Goodwill
– An intangible asset that exists when a
business is valued at more than the fair
market value of its net assets, usually due to:
• Strategic location
• Reputation
• Good customer relations
• Equal to the excess of the purchase price
over the fair market value of the net assets
purchased.
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Accounting for Goodwill
Dahl & Sons purchased Clark & Associates for $1,200,000.
At the time, the following market values existed for Clark’s
assets and liabilities:
Inventory
Long-term operating assets
Other assets
Liabilities
Total Net Assets
$750,000
220,000
25,000
(18,000)
$977,000
Inventory. . . . . . . . . . . . . . . . . . . . . .
750,000
Long-Term Operating Assets . . . .
220,000
Other Assets. . . . . . . . . . . . . . . . . .
25,000
Goodwill . . . . . . . . . . . . . . . . . . . . .
223,000
Liabilities. . . . . . . . . . . . . . . . . .
18,000
Cash . . . . . . . . . . . . . . . . . . . . . .
1,200,000
Purchased Clark & Associates for $1,200,000.
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Measuring the Management of
Long-Term Assets
• Fixed Asset Turnover
– The amount of dollars in sales generated by
each dollar of fixed assets.
Sales
Average PP&E
– Standard values for this ratio differ from
industry to industry.
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Accelerated Depreciation
Methods
• Declining-balance method
– An asset’s book value is multiplied by a
constant depreciation rate.
• This is double the straight-line percentage in the
case of double-declining balance (DDB).
• Sum-of-the-years’-digits method
– A constant balance (cost minus salvage
value) is multiplied by a declining depreciation
rate calculated based off of the sum of the
years.
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Double-Declining-Balance
Double- Book Value
Depreciation
X2=
Declining Asset’s Life
Expense
in Years
Balance
Book Value = Cost – Accumulated Depreciation
Dahl & Sons purchased a truck for $12,000. The truck has a salvage value of
$2,000 and a useful life of 4 years. Compute depreciation using the DDB
depreciation method for the first 2 years.
Year 1
Year 2
($12,000 – 0) X 2 =
4
($12,000 – $6,000)
X2=
4
$6,000
$3,000
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Sum-of-Years’-Digits Method
Sum-of(Cost – Salvage Value)
the-Year’sCurrent
Year
/
(4+3+2+1)
Digits
Sum of the
years of the
asset’s life
Dahl & Sons purchased a truck for $12,000. The truck has a salvage value of
$2,000 and a useful life of 4 years. Compute depreciation using the SYD
depreciation method for the first 2 years.
Year 1
($12,000 – $2,000)
4/(4+3+2+1)
$4,000
Year 2
=
($12,000 – $2,000)
3/(4+3+2+1)
=
$3,000
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Change in Depreciation
Estimates and Methods
• Depreciation is only an estimate.
– Changes in estimates of useful life and
salvage value may occur.
– Changes in method can also occur.
• When there is a change in estimate, past
periods’ depreciation amounts remain the
same.
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