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©2006 Prentice Hall, Inc.
REPORTING & INTERPRETING
L-T OPERATIONAL ASSETS (1 of 2)
 Learning
objectives
 Acquiring plant assets
 Using long-term tangible assets—
depreciation and depletion
 Using intangible assets—amortization
 Changes after the purchase of an
asset
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©2006 Prentice Hall, Inc.
REPORTING & INTERPRETING
L-T OPERATIONAL ASSETS (2 of 2)
 Selling
long-term assets
 Long-term asset presentation on
financial statements
 Financial statement analysis
 Business risk, control, and ethics
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Learning Objectives
(1 of 3)
 Explain
how long-term assets are
classified, how their cost is
computed, and how they are
reported
 Explain and compute how tangible
assets are written off over their useful
lives and reported on the financial
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statements
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Learning Objectives
(2 of 3)
 Explain
how decreases in value, repairs,
changes in productive capacity, and
changes in estimates of useful life and
salvage value of assets are reported on
the financial statements
 Describe how long-term assets are
reported on the financial statements
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Learning Objectives
(3 of 3)
 Describe
how long-term assets are
reported on the financial statements
 Use return-on-assets (ROA) and the
asset turnover ratio to help evaluate
the firm’s performance
 Recognize the risks associated with
long-term assets and the controls that
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can minimize those risks
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Acquiring Plant Assets
(1 of 2)
 Long-term
operational assets
Assets
that last for more than one
accounting period
Used to help a business generate
revenue
 Does
purchase of a plant asset affect
the income statement?
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Acquiring Plant Assets
(2 of 2)
 Types
of long-lived assets
Tangible
assets
Property,
Intangible
plant, and equipment
assets
Trademarks,
patents, copyrights, etc.
 Acquisition
costs
 Basket purchase allocation
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Acquisition Costs
(1 of 2)
 Historical
cost principle requires assets
to be recorded at their cost
Plus
cost of getting asset in place and
ready for use
Why aren’t most long-term assets
reported at their current market value?
Why aren’t long-term assets immediately
expensed when purchased?
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Acquisition Costs
(2 of 2)
 Which
of the following are acquisition
costs for a building and why?
Real
estate commissions
Cost of tearing down an existing building
Consultant’s fee to decide whether to
lease or purchase the building
Installation fees
Cost of land where building will be built 8-10
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Basket Purchase Allocation
 Purchase
of two or more assets for
one price
 Cost allocated to each asset based on
their relative fair market values
Percent
of total FMV of the assets
How do firm’s determine an asset’s
current fair market value?
 Basket
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purchase example
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Basket Purchase Example
(1 of 2)
 On
July 1, Valdez Environmental
purchased a tug boat and oil cleaning
equipment for $7M
 FMV of tug boat is $4M
 FMV of oil cleaning equipment is $6M
 How much of the $7M will be
allocated to the tug boat and to the oil
cleaning equipment?
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Basket Purchase Example
(2 of 2)
Relative FMV
Tug Boat
Cleaning Equip
Total
Allocation
Tug Boat
Cleaning Equip
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FMV
_
X
X
_
$7M =
$7M =
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Using L-T Tangible Assets:
Depreciation and Depletion (1 of 3)
 Purchase
of long-term tangible assets are
capitalized (recorded as assets)
 L-T tangible assets expensed by
depreciating (or depleting) them
Depreciation
allocates the COST of an asset
to the periods that benefit from the use of
the asset
What
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accounting principle requires this (ch 2)?
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Using L-T Tangible Assets:
Depreciation and Depletion (2 of 3)
 Depreciation
terminology
Acquisition
cost (cost)
Estimated useful life
Salvage value (residual value)
Estimated
value of an asset at the end of
its useful life
Depreciable
base = cost - salvage value
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Book value (carrying value)
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Using L-T Tangible Assets:
Depreciation and Depletion (3 of 3)
 Depreciation
methods
Straight-line
Activity
(units of production)
Declining balance
 Depreciation
example
 Depletion
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Estimated Useful Life
 How
long a company expects an
asset to be productive
May
be expressed in years or units of
activity (e.g., miles, hours, # of units
produced)
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Book Value
 Book
value equals cost less
accumulated depreciation
 The unexpensed portion of an asset
 Book value bears NO relationship to
FMV
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Straight line Depreciation
 Equal
amount of an asset are expensed
each year
Depreciable
base is constant (cost-SV)
Depreciation rate is constant (1/UL)
Depreciable cost (cost - SV)
Useful life (in years)
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Activity (Units of Production)
Depreciation
 Amount
of asset expensed each year
depends on asset’s usage
Depreciable
base is constant (cost-SV)
Depreciation rate is constant (1/UL)
Depreciable
cost
(cost
SV)
Depr Rate =
Useful life in units
 Annual depreciation expense
depr
rate x actual level of activity for year8-20
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Declining Balance Depreciation
(1 of 2)
 Accelerated
depreciation method
Annual
depreciation expense declines over
asset’s useful life
Depreciable base changes (beg book value)
Depreciation rate is constant (X/UL)
X
= Depreciation rate
 Most
common rate is 200%
 Also called double-declining balance (DDB)
Never
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depreciate below salvage value
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Declining Balance Depreciation
(2 of 2)
2_
DDB Exp =
x Book value (cost – A/D)
UL
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Depreciation Example
(1 of 5)
 Photocopier
purchased on 1/1/08
 Acquisition cost $14,000
 Useful life
5
years or
300,000 copies
 Estimated
salvage value $2,000
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Depreciation Example
(2 of 5)
 Straight-line
method
=$2,400/year
$14,000 - $2,000
5 years
 Activity
method
Assume
40,000 copies were made
$14,000 - $2,000 x 40,000 =$1,600
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300,000 copies
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Depreciation Example
(3 of 5)
 Double-declining
Year
balance method
1
2 _ x $14,000 = $5,600
5 yrs
Year
2
2 _ x ($14,000 - $5,600) = $3,360
5 yrs
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Depreciation Example
(4 of 5)
SL
Yr
1
2
3
4
5
Exp
2,400
2,400
2,400
2,400
2,400
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A/D
2,400
4,800
7,200
9,600
12,000
DDB
Exp
A/D
5,600 5,600
3,360 8,960
2,016 10,976
1,024 12,000
- 12,000
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Depreciation Example
(5 of 5)
 Which
method (SL or DDB) produces
the highest income in the earliest years?
 Which method has the highest book
value throughout the asset’s life?
 Which method is best for income
smoothing?
 Which method produces the best asset
turnover ratio over the asset’s life? 8-27
©2006 Prentice Hall, Inc.
Depletion
 Used
to expense natural resources as
they are used up
Same
computation to activity depreciation
with zero salvage value
Cost
_
Depl rate =
Useful life in units
 Annual depletion expense
depl
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rate x actual level of activity for year
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Using Intangible Assets:
Amortization (1 of 3)
 Rights,
privileges, or benefits that have
long-term value to the firm
 Recorded at cost
 Amortization
Same
method of expensing as straightline depreciation with zero salvage value
Accumulated amortization calculated for
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each intangible asset
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Using Intangible Assets:
Amortization (2 of 3)
 Copyright
Provides
U.S. legal protection for authors of
original work
Amortized over shorter of legal or useful life
 Patent
A
property right on inventions
Amortized over shorter of legal life (20
years) or useful life (often around 10 years)
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©2006 Prentice Hall, Inc.
Using Intangible Assets:
Amortization (3 of 3)
 Trademarks
10
years of protection; renewable
 Franchise
Agreement
that authorizes someone to sell
or distribute a company’s goods or services
in a certain area
 Goodwill
 Research and
Immediately
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development costs
expensed. Why?
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Goodwill
 Excess
of cost over FMV of net assets
when one company purchases another
company
Why
would a company pay more than the
FMV of the net assets for a company?
 Goodwill
Loss
is not amortized
recorded for decrease in value
Reported in the notes to the financial
statements
©2006 Prentice Hall, Inc.
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Changes After an Asset Purchase
(1 of 2)
 Asset
impairment
Permanent
reduction in market value
below book value
Similar to LCM method for inventory
 Capital
expenditures to improve or
extend an asset’s useful life
Capitalize
and depreciate
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©2006 Prentice Hall, Inc.
Changes After an Asset Purchase
(2 of 2)
 At
what point does a roof repair
become a capital expenditure?
 Revising estimates of useful life and
salvage value
Depreciate
remaining depreciable cost
over remaining useful life
Revising estimate example
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©2006 Prentice Hall, Inc.
Revising an Estimate Example
(1 of 2)
 Facts
Asset
cost: $30,000
Original useful life: 5 years
Original salvage value: $8,000
In the beginning of year 3, the asset is
determined to have 4 years of useful
life remaining and a salvage value of
$6,000
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Revising an Estimate Example
(2 of 2)
 Depreciation
($30,000
 Book
- $8,000)/5 = $4,400/yr
value at beginning of year 3
($30,000
- $8,800) = $21,200
 Depreciation
($21,200
4
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expense for yr 1 & 2
expense yr 3-6
- $6000)/4 = $3,800/yr
=remaining years of useful life
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Selling Long-term Assets
(1 of 2)
 Cash
proceeds > BV = gain
 Cash proceeds < BV = loss
 Cash proceeds = BV = no gain/loss
 Journal entry
Increase
cash (debit)
Remove asset (credit)
Remove A/D (debit)
Record gain (credit) or loss (debit)
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Selling Long-term Assets
(2 of 2)
 Sold
asset for $20,000 cash
Cost
$35,000; A/D $18,000
Assets = Liab.
Date
Transaction
+ Cont. Cap. +
Debit
R/E
Credit
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©2006 Prentice Hall, Inc.
Long-term Asset Presentation on
Financial Statements
 PP&E
may be reported on the
financial statements at book value or
showing cost and A/D
 How can you calculate the average
age of depreciable assets when all
you have is cost, A/D and depr exp?
Could
A/D?
©2006 Prentice Hall, Inc.
you do this if you did not know
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Financial Statement Analysis
(1 of 3)
 Return
on assets (ROA)
Measures
how well a company is using
its assets to generate revenue
Answers
 Did
the following
the company invest wisely in its assets?
Net Income + Interest Expense
Average Total Assets
Avg
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total assets = (Beg TA + End TA)/2
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Financial Statement Analysis
(2 of 3)
 Interest
expense results from financing
with debt instead of equity
Why
is interest expense added back to
net income to compute ROA?
 How
can a company increase its ROA
without increasing its net income?
 Compare the ROA of a CPA firm to
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the ROA of an auto manufacturer
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Financial Statement Analysis
(3 of 3)
 Asset
Turnover Ratio
Measures
how efficiently a company uses
its assets to generate sales
Net Sales
_
Average Total Assets
 Explain how a company can have a
high asset turnover and a low ROA
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Business Risk, Control, and Ethics
(1 of 2)
 Risks
associated with long-term assets
Theft,
vandalism, natural disasters,
terrorist attacks, etc.
 Controls
used to safeguard assets
Physical
controls
Complete and reliable record keeping
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Business Risk, Control, and Ethics
(2 of 2)
 Controls
used to safeguard assets
(continued)
Monitoring
Make
sure that physical controls,
separation of duties, and other policies
and procedures related to protecting assets
are operating properly
Who is responsible for monitoring
function?
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Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
richard.newmark@PhDuh.com
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