Using Financial
Accounting Information:
The Alternative to Debits and Credits
Fifth Edition
Gary A. Porter and Curtis L. Norton
Chapter 8, Slide #1
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo,
and South-Western are trademarks used herein under license.
Nike, Inc.
Property, Plant, and Equipment
(in millions)
May 31, 2004
Property, plant, and equipment, net $ 1,586.9
Identifiable intangible assets, net
366.3
Goodwill
135.4
Deferred income taxes and other assets
291.0
Chapter 8, Slide #2
LO1
Acquisition Cost of Property, Plant,
and Equipment
 All of the costs necessary to acquire the
asset and prepare it for its intended use
Purchase
price
+
Taxes
Chapter 8, Slide #3
Transportation charges
Installation
costs
LO2
Group Purchase
Allocate cost of lump-sum purchase based on
fair market values
Cost
$100,000
Fair Market
Value
Building =
$90,000
Land =
$30,000
Chapter 8, Slide #4
% of
Market
Value
75%
25%
Allocated
Cost
$75,000
$25,000
LO3
Capitalization of Interest
 Interest can be included as part of the
cost of an asset if the company:
• Constructs the asset over time
and
• Borrows money to finance construction
Chapter 8, Slide #5
LO 4
Depreciation of Property, Plant, and
Equipment
Match cost of assets
with periods benefited
via
Straight Line
Chapter 8, Slide #6
Units of
Production
Double
Declining
Balance
LO5
Straight-Line Method
 Allocates the cost of the asset evenly over
its useful life
$9,000
3-year life
$3,000
Year 1
Chapter 8, Slide #7
$3,000
Year 2
$3,000
Year 3
Units-of-Production Method
 Allocates the asset cost based on the
number of units produced over its useful
life
depreciation =
$ per unit
Chapter 8, Slide #8
Double-Declining-Balance Method
 Accelerated method – higher amount of
depreciation in early years
 Double the straight-line rate on a declining
amount (book value)
Straight-line
rate
Chapter 8, Slide #9
X
2
Depreciation Example
On January 1, ExerCo purchases a
machine for $20,000. The life of the machine
is estimated at 5 years, after which it is
expected to be sold for $2,000.
Chapter 8, Slide #10
Depreciation Example
Calculate ExerCo’s depreciation of the
machine for years 1 through 5 using the
straight-line, units-of-production and doubledeclining-balance depreciation methods.
$20,000 cost – $2,000 residual value =
$18,000 to be depreciated
Chapter 8, Slide #11
Straight-Line Depreciation
Depreciation
$18,000
5-year life
$3,600
Year 1
Chapter 8, Slide #12
$3,600
Year 2
= Cost – Residual Value
Life
= $20,000 – $2,000
5 years
= $3,600
$3,600
Year 3
$3,600
Year 4
$3,600
Year 5
Units-of-Production Depreciation
 ExerCo’s estimated machine production:
Year 1
Year 2
Year 3
Year 4
Year 5
Total
Chapter 8, Slide #13
3,600 units
3,600 units
3,600 units
3,600 units
3,600 units
18,000 units
Units-of-Production Depreciation
Depreciation
per unit
= Cost – Residual Value
Life in Units
= $20,000 – $2,000
18,000
= $1.00 per unit
Chapter 8, Slide #14
Units-of-Production Depreciation
 ExerCo’s Depreciation in 2007:
4,000 Units × $1 per Unit = $ 4,000
Chapter 8, Slide #15
Double-Declining-Balance
Depreciation
DDB Rate = (100%/Useful Life) × 2
= (100%/5 Years) × 2
= 40%
Initially
ignore
residual value
Chapter 8, Slide #16
Double-Declining-Balance
Depreciation
2007 Depreciation = Beginning Book Value × Rate
= $20,000 × 40%
= $8,000
Book Value at
Book Value at
Year Rate Beginning of Year Depreciation End of Year
2007 40%
$20,000
$8,000
$12,000
Chapter 8, Slide #17
Double-Declining-Balance
Depreciation
2008 Depreciation = Beginning Book Value × Rate
= $12,000 × 40%
= $4,800
Book Value at
Book Value at
Year Rate Beginning of Year Depreciation End of Year
2007 40%
$20,000
$8,000
$12,000
2008 40
12,000
4,800
7,200
Chapter 8, Slide #18
Double-Declining-Balance
Depreciation
Year
2007
2008
2009
2010
2011
Book Value at
Book Value at
Rate Beginning of Year Depreciation End of Year
40%
$20,000
$ 8,000
$12,000
40
12,000
4,800
7,200
40
7,200
2,880
4,320
40
4,320
1,728
2,592
40
2,592
592
2,000
$18,000
Final year’s depreciation =
amount needed to equate book
value with salvage value
Chapter 8, Slide #19
= Residual
Value
Straight-Line vs. Double-DecliningBalance Depreciation
$8,000
$7,000
$6,000
$5,000
Straight-Line
$4,000
Double-DecliningBalance
$3,000
$2,000
$1,000
$0
Year 1
Chapter 8, Slide #20
Year 2
Year 3
Year 4
Year 5
Reasons for Choosing the StraightLine Method
Simplicity
Reporting to stockholders
Comparability
Bonus plans
Chapter 8, Slide #21
Reasons for Choosing Accelerated
Methods
 Technological rate of change and
competitiveness
 Minimize taxable income
 Comparability
Chapter 8, Slide #22
Change in Depreciation Estimate
 Recompute depreciation schedule using
new estimates
 Record prospectively (i.e., change should
affect current and future years only)
Chapter 8, Slide #23
LO6
Change in Depreciation Estimate
Example:
A $20,000 machine purchased on January 1, 2007 is
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
2007
2008
2009
Depreciation
Chapter 8, Slide #24
revise
estimate
2010
2011
Change in Depreciation Estimate
Example:
 $12,800 remaining book value allocated
prospectively over remaining life
$3,600
$3,600
$2,160
$2,160
$2,160
$2,160
$2,160
2007
2008
2009
2010
2011
2012
2013
revise
estimate
Chapter 8, Slide #25
Depreciation
Capital vs. Revenue Expenditures
 Capital Expenditure
• Treat as asset addition to
be depreciated over a
period of time
 Revenue Expenditure
• Expense immediately
Chapter 8, Slide #26
Balance
Sheet
Income
Statement
LO7
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
*if life or productivity is enhanced
Chapter 8, Slide #27
Asset or Expense
Expense
Expense
Asset*
Asset
Capital Expenditures
Example:
A $20,000 machine purchased on January 1, 2007 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
2007
2008
2009
Chapter 8, Slide #28
replace
engine
2010
2011
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
2007
2008
2009
2010
2011
2012
2013
replace
engine
Chapter 8, Slide #29
Disposal of Property, Plant, and
Equipment
 Record depreciation up to date of disposal
 Compute gain or loss on disposal
Selling Price > Book Value = Gain
Selling Price < Book Value = Loss
Chapter 8, Slide #30
LO8
Disposal of Property, Plant, and
Equipment
Example:
 Sell machine (cost $20,000; accumulated
depreciation $9,000) for $12,400
Asset cost
$20,000
Less: Accumulated depreciation
9,000
Book value
$11,000
Sale price
12,400
Gain on sale of asset
$ 1,400
Chapter 8, Slide #31
Weyerhaeuser Company
Partial Balance Sheet
(in millions)
Property and equipment, net
Construction in progress
Investments in and advances
to equity affiliates
Goodwill
Timber and timberlands at cost, less
depletion charged to disposals
Natural Resources
Chapter 8, Slide #32
2004
11,843
269
489
3,244
4,212
Natural Resources
 When a natural resource is used or
consumed, it should be treated as an expense
 Recording the expense is referred to as
depletion
 Depletion method is similar to the units-ofproduction method
Chapter 8, Slide #33
Intangible Assets
 Long-term assets with no physical
properties
Patents
Copyrights
Chapter 8, Slide #34
Trademarks
Goodwill
LO9
Intangible Assets
 Includes cost to acquire and prepare for
intended use
Purchase Price
+
Chapter 8, Slide #35
Acquisition
Costs
(i.e. legal fees,
registration
fees, etc.)
Nike, Inc.
Partial Balance Sheet
(in millions)
2004
Amortized intangible assets:
Patents
Trademarks
Other
$ 16.0
2.6
6.2
$ 24.8
Unamortized intangible assets:
Trademarks
Total
Chapter 8, Slide #36
$341.5
$366.3
Research and Development Costs
 Must be expensed in period incurred
 Difficult to identify future benefits
Chapter 8, Slide #37
Amortization of Intangibles
 Normally recorded using the straight-line
method
 Reported net of accumulated amortization
 Amortized over the legal or useful life,
whichever is shorter
Chapter 8, Slide #38
LO10
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.
Chapter 8, Slide #39
Amortization of Intangibles
To record amortization of patent for one year:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Accumulated
Patent Expense (2,000)
Amortization (2,000)
Nike’s annual amortization:
Patent approval costs
Divided by:
Lesser of legal or useful life
Annual amortization
Chapter 8, Slide #40
$10,000
5 years
$ 2,000
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
Chapter 8, Slide #41
xxx
+
–
+
–
+
LO11
Analyzing Long-Term Assets
Property, Plant, and Equipment
Average Life =
Depreciation Expense
What is the
average
depreciable
period (or life) of
the company’s
assets?
Chapter 8, Slide #42
LO12
Analyzing Long-Term Assets
Accumulated Depreciation
Average Age = Depreciation Expense
Are assets old or
new?
Chapter 8, Slide #43
Analyzing Long-Term Assets
Net Sales
Asset Turnover =
Average Total Assets
How productive
are the company’s
assets?
Chapter 8, Slide #44
End of Chapter 8
Chapter 8, Slide #45