Chapter 8
Operating Assets:
Property, Plant, and Equipment,
and Intangibles
Using Financial Accounting Information:
The Alternative to Debits and Credits, 6e
by
Gary A. Porter and Curtis L. Norton
Copyright © 2009 South-Western, a part of Cengage Learning.
Nike, Inc.
Property, Plant, and Equipment
2006
(in millions)
Land
Buildings
Machinery and equipment
Leasehold improvements
Construction in progress
Less accumulated depreciation
Property, plant, and equipment (net)
$
At
Cost
195.9
842.6
1,661.7
626.7
81.4
$ 3,408.3
(1,750.6)
$ 1,657.7
Book Value
LO 1
Acquisition Cost of PP&E
All costs necessary to acquire asset and
prepare for intended use
Examples:
Purchase price
Purchase
PriceTaxes paid at time of purchase
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
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
x
2
Depreciation Example
On January 1, 2008, 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 2008-2012 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
2008
$3,600
2009
= $20,000 - $2,000
5 years
=
$3,600/year
$3,600
2010
$3,600
2011
$3,600
2012
Units-of-Production
Depreciation
ExerCo’s
estimated machine production:
2008
2009
2010
2011
2012
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 2008:
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
2008 Depreciation = Beginning book value x rate
=
$20,000
x 40%
=
$8,000
Year
2008
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
2008
2009
2010
2011
2012
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
$8,000
$7,000
$6,000
$5,000
$4,000
Straight-line
DDB
$3,000
$2,000
$1,000
$0
Year 1
2008
Year 2
2009
Year 3
2010
Year 4
2011
Year 5
2012
20
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:
$12,800 remaining book value allocated prospect over
remaining life
$3,600
$3,600
$2,160
$2,160
$2,160
$2,160
$2,160
2008
2009
2010
2011
2012
2013
2014
Revise
estimate
Depreciation
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
Asset or Expense
Repainting
Expense
Replace spark plugs
Expense
Replace a vehicle’s
engine
Asset*
Add a wing to a
building
Asset
*if life or productivity is enhanced
Capital Expenditures
Example:
A $20,000 machine purchased on January 1, 2008 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
2008
2009
2010
Major
overhaul
2011
2012
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
2014
Major
overhaul
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
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
Unamortized intangible assets:
Trademarks
Total
Goodwill
2006
$ 23.6
34.6
5.8
$ 64.0
$341.5
$405.5
$130.8
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
Only amortize intangible assets with definite life
E.g.. Patents, copyrights
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
with Finite Life
To record amortization of patent for one year
Balance Sheet
Assets =
Liabilities + Stockholders’ +
Equity
Patent (2,000)
Nike’s annual amortization:
Patent approval costs
Divided by:
Lesser of legal or useful life
Annual amortization
Income Statement
Revenues - Expenses
Patent Amortization
Expense (2,000)
$10,000
5 years
$ 2,000
Intangibles with Indefinite Life
These intangibles are not amortized
E.g., Broadcast license, trademarks, goodwill
Should test annually for “impairment”
 If asset is impaired, record “Loss on Impairment”
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