McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008

LO 1
9-2

Tangible assets have a physical presence; they can be seen and touched.
Intangible assets are rights or privileges.
They cannot be seen or touched.
9-3

Tangible Long-Term Assets
1. Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.
2. Natural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life.
3. Land – Has an infinite life and is not subject to depreciation.
9-4

Intangible Assets
1. Intangible Assets with Identifiable
Lives – patents and copyrights.
Useful
• amortize the cost of each over its useful life.
2. Intangible Assets with Indefinite Useful Lives renewable franchises, trademarks, and goodwill.
• The cost of these assets is not expensed unless it can be shown that there has been an impairment in value.
9-5

LO 1
9-6

Cost of Long-Term Assets
Buildings
•Purchase price
•Sales taxes
•Title search and transfer document costs
•Realtor’s and attorney’s fees
•Remodeling costs
Equipment
•Purchase price (less discounts)
•Sales taxes
•Delivery costs
•Installation costs
•Costs to adapt to intended use
9-7

Cost of Long-Term Assets
Land
•Purchase price
•Sales taxes
•Title search and transfer document costs
•Realtor’s and attorney’s fees
•Costs of removal of old buildings
•Grading costs
9-8

Basket Purchase Allocation
Beatty Co. purchased land and a building for $240,000 cash. An appraiser estimated that the land has a fair market value of $90,000, and the building has a fair market value of $270,000. How will we assign the $240,000 cost between the land and building?
Fair market value of land
Total fair market value
90000/360000
Amount
Fair market value of building 270000/360000 $ 270,000
90,000
$ 360,000
%
75%
25%
100%
Assign to building
Assign to land
Cost
$ 240,000
240,000
%
75%
25%
100%
Allocation
$ 180,000
60,000
$ 240,000
9-9

9-10

LO 1
9-11

Depreciation Methods
1. Straight-line method - the same amount is depreciated each accounting period.
2. Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years.
3. Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.
9-12

Asset to be Depreciated
List price of van
Cash discount
Transportation cost
Cost of customization
Cost of van
$ 23,500
(2,350)
250
2,600
$ 24,000
The van has a salvage value of $4,000, and an estimated useful life of four years.
9-13

Straight-Line Depreciation
Life Cycle Phase 1
Acquire $25,000 cash from the sale of common stock to purchase the van.
Assets
Cash + Van
25,000 NA
= Equity Rev.
– Exp. = Net Inc. Cash Flow
AccDep = Com. Stk. Ret. Earn.
= NA = 25,000 NA NA
– NA
= NA 25,000 FA
Cash $25,000
Common Stock $25,000
9-14

Straight-Line Depreciation
Life Cycle Phase 2
Purchase the van on January 1, 2008, for a net cost of $24,000.
Assets
Cash
(24,000)
+ Van
24,000
= Equity
AccDep = Com. Stk.
Ret. Earn.
= NA = NA NA
Rev.
– Exp. = Net Inc.
Cash Flow
NA – NA = NA (24,000) IA
Van $24,000
Cash $24,000
9-15

Straight-Line Depreciation
Life Cycle Phase 3
Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed:
(Asset Cost – Salvage Value) ÷
Useful Life
($24,000 – $4,000) ÷
4 = $5,000 depreciation
Assets = Liab.
+ Equity
Cash + Truck A. Dep.
8,000 NA NA
NA NA 5,000
= NA
NA
+ 8,000
(5,000)
Rev.
8,000
NA
–
Exp.
= Net Inc.
– NA =
–
5,000
8,000
(5,000)
Cash Flow
8,000 OA
NA
9-16

Journal Entries
Cash $8,000
Revenue $8,000
Depreciation Expense $5,000
Accumulated Dep. Van $5000
Accumulated Depreciation is a Contra Asset Account used to track the total loss of value of the attached asset so far. The
Asset account in this case the VAN always shows the historical cost. $24,000. After one year the book value is $19,000.

LO 1
9-18

Straight-Line Depreciation
Life Cycle Phase 4
On January 1, 2012, the van is sold for $4,500 cash. The van was purchased on January 1, 2008.
Cost of Asset
Accumulated Depreciation
Book Value
Cash Proceeds
Gain on disposal
$ 24,000
20,000
4,000
4,500
$ 500
($5,000 × 4 years)
Assets = Liab.
+ Equity
Cash
4,500
+ Van
(24,000)
A. Depr
(20,000) = NA +
Ret. Earn.
500
Cash $4,500
Accumulated Dep. $20,000
Gain on sale $500
Van $24,000
Gain
– Exp.
= Net Inc.
500
–
= 500
Cash Flow
4,500 IA
9-19

9-20

The double-declining-balance method is called an accelerated depreciation method because more depreciation expense is recorded in the early years than in later years. Determining the amount of depreciation expense in any year is the result of a three-step process.
1. Determine the straight-line rate of depreciation.
Divide 1 by the assets useful life = straight line rate
2. Multiply the straight-line rate times two .
3. Multiply the double-declining rate by the book value of the asset at the beginning of the period.
9-21

See how double-declining-balance depreciation works
(1 ÷ 4) = (25% straight-line rate × 2) = 50%
Book Value at
Year Beginning of Year
2008 ($24,000 – $ 0)
2009 ($24,000 – $12,000)
2010
($24,000 – $18,000)
2011 ($24,000 - $20,000)
=12,000
=6,000
=4,000
Double the
Straight-Line
Rate
50%
50%
50%
50%
Annual
Depreciation
Expense
$ 12,000
6,000
3,000
2,000
$ 23,000
2,000
0
Total Depreciation can only be
Cost – Salvage Value = Total Depreciation
$20,000
9-22

Cost
– Salvage value
Total estimated units of production
=
Depreciation charge per unit of production
Depreciation charge per unit of production
×
Units of production in current accounting period
=
Periodic
Depreciation
Expense
9-23

Here is the depreciation charge per mile driven in our van:
$24,000 – $4,000
100,000 miles
= $0.20 per mile
Here is the calculation of depreciation expense based on miles driven:
Depreciation
Charge Per
Mile
$ 0.20
0.20
0.20
0.20
×
×
×
×
Miles
Driven
40,000
20,000
30,000
15,000
105,000
=
=
=
=
Depreciation
Expense
$ 8,000
4,000
6,000
3,000
$ 21,000
2,000
Can’t depreciate below the salvage value of $20,000
9-24

9-25

LO 1
9-26

Income Tax Considerations
The maximum depreciation currently allowed by tax law is computed using the modified accelerated cost recovery system (MACRS). The rate of depreciation depends on the class life of the asset and the period in which we are calculating depreciation. There are currently six categories for property, excluding real estate. They are 3-year, 5-year, 7-year, 10-year, 15year, and 20-year property.
9-27

Income Tax Considerations
Here are the tax rates for 5-year and 7-year property:
Year
1
2
3
5-Year
Property %
20.00%
32.00%
19.20%
7-Year
Property %
14.29%
24.49%
17.49%
4
5
6
7
11.52%
11.52%
5.76%
12.49%
8.93%
8.92%
8.93%
8 4.46%
100.00% 100.00%
Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.
9-28

Income Tax Considerations
Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.
Year
1
2
3
4
5
6
5-Year
Property % Cost of Van
20.00% $ 24,000
32.00%
19.20%
24,000
24,000
11.52%
11.52%
5.76%
100.00%
24,000
24,000
24,000
Depreciation
Expense
$ 4,800
7,680
4,608
2,765
2,765
1,382
$ 24,000
9-29

LO 1
9-30

Revision of Estimates
Estimates are revised when new information surfaces.
Prior Reports are not corrected!!!
Assume we purchased equipment on January 1, 2008, for $50,000 cash and estimated salvage value was
$3,000. The equipment has an estimated useful life of eight years, and we use straight-line depreciation.
($50,000 – $3,000) ÷
8 = $5,875 depreciation per year
On January 1, 2012, after four years of depreciation, it was determined that the machine has a useful life of
14.
($26,500 – $3,000) ÷
10 = $2,350 depreciation per year
9-31

Revision of Estimates
At the beginning of the 5 th year the machine had Accumulated
Depreciation of $23,500. ($5,875 x 4) The machines book value was
$26,500. ($50,000-$23,500).
At this point it was determined a revision in the life of the machine is expected to be 14 years instead of 8 year. This means the life of the machine now has 10 more years. (14-4) If we assume the salvage value stays at $3,000 the following would be the new depreciation for each year will be $2,350. ($26,500 BV - $3,000 salvage value / 10)
OR
At this point it was determined the salvage value was changed. The salvage value is now estimated to be $6,000 with the original 4 years remaining. The new depreciation would be $5,125 ($26,500 BV - $6,000
Salvage value / 4)

LO 1
9-33

Costs that Are Expensed
The cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume the company spent $200 cash for routine maintenance on machinery.
Assets = Liab.
+ Equity
Cash
(200) = NA +
Ret. Earn.
(200)
Rev.
– Exp.
= Net Inc.
NA – 200 = (200)
Cash Flow
(200) OA
Account Title
Maintenance Expense
Cash
Debit
200
Credit
200
9-34

Costs that Are Capitalized
Expenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume the company spent $5,000 cash for a major overall of equipment to improve efficiency.
Rev.
– Exp.
= Net Inc.
Cash Flow Assets
Cash
(5,000)
+ Equip.
A. Depr
5,000 NA
= Liab.
+ Equity
= NA + NA NA – NA = NA (5,000) IA
Account Title
Equipment
Cash
Debit
5,000
Credit
5,000
9-35

Depreciation Calculation for Capitalization when a plant asset is improved
EX: An asset which originally cost $50,000 and has a salvage value of $3,000 with a life expectancy of 8 years will have its depreciation expense altered if at the beginning of the fifth year the company spends $4,000 money is spent to improve its efficiency.
The first four years of depreciation would be $5,875 using the straight line method. ($50,000 - $3000 = $47,000/8 = $5,875
At the end of the fourth year the book value would be $26,500.
4 X $5,875 = $23,500 $50,000 - $23,500 = $26,500.
Since the $4,000 improves the efficiency you add the $4,000 to the asset. This would give the asset a new book value of $30,500. $26,500 + $4,000 = $30,500
The new depreciation would be $6,875. ($30,500 - $3,000 salvage / 4 remaining years = $6,875)

Costs that Extend the Life of an Asset
The amount of the expenditure should reduce the balance in the accumulated depreciation account. Assume the company spent $8,000 cash for improvements that extended the life of equipment four years.
Assets = Liab.
+ Equity
Cash
(8,000)
+ Equip.
A. Depr
NA (8,000) = NA + NA
Rev.
– Exp.
= Net Inc.
NA – NA = NA
Cash Flow
(8,000) IA
Account Title
Accumulated Depreciation - Equipment
Cash
Debit
8,000
Credit
8,000
9-37

Depreciation Calculation for Capitalization when a plant assets life is extended.
When the cost extends the life but does not improve the productivity you reduce the Accumulated Depreciation for that asset.
Ex: The company spends $4,000 which will extend the life of the asset two more years.
Using the same problem as before. You can use one of two methods.
So far the assets accumulated depreciation was $23,500. 4 x $5,875 You now subtract the $4,000 from this to get an adjusted accumulated depreciation of
$19,500. The new book value would be $30,500 ($50,000 - $19,500 AD) Then
$30,500 Book value - $3,000 salvage value / 6 years (4 remaining + 2 extra) =
$4,583.33 depreciation
OR Original book value $26,500 + $4,000 = New BV $30,500 -
$3,000 salvage value / 6 = $4,583.33

LO 1
9-39

Natural Resources
Cost
– Salvage value
Total estimated units recoverable
=
Depletion charge per unit of resource
Depletion charge per unit of resource
×
Number of units extracted and sold = this period
Periodic
Depletion
Expense
9-40

Natural Resources
Apex Coal Mining paid $4,000,000 cash to purchase a mine expected to yield 16,000,000 tons of coal. After all coal is extracted the mine is not expected to have any salvage value. During the year, the company extracted and sold 360,000 tons of coal.
$4,000,000 – $0
16,000,000 tons
= $0.25 per ton extracted and sold
9-41

Natural Resources
Apex Coal Mining paid $4,000,000 cash to purchase a mine expected to yield 16,000,000 tons of coal. After all coal is extracted the mine is not expected to have any salvage value. During the year, the company extracted and sold 360,000 tons of coal.
.25 x 360,000 = $90,000
Assets = Liab.
+ Equity Rev.
– Exp.
= Net Inc.
Cash Flow
Cash
(4,000,000)
NA
+ Coal Mine
4,000,000
(90,000)
= NA +
NA
NA
(90,000)
NA –
NA –
NA
(90,000)
= NA
(90,000)
(4,000,000) IA
NA
Account Title
Coal Mine
Cash
Depletion Expense
Coal Mine
Debit
4,000,000
90,000
Credit
4,000,000
90,000
9-42

LO 1
9-43

Intangible Assets
Trademarks
A name or symbol that identifies a company or a product. The cost of a trademark may include design, purchase, or defense of the trademark.
Patents
The exclusive legal right to produce and sell a product that has one or more unique features. The legal life of a patent is 20 years.
9-44

Intangible Assets
Copyrights
Protection of writings, musical composition, work of art, or other intellectual property. The protection extends for the life of the creator plus 70 years.
Franchise
The exclusive right to sell products or perform services in certain geographic areas.
9-45

Intangible Assets
Goodwill
The excess of cost over fair value of net tangible assets acquired in a business acquisition.
Assets
Assume that your company is willing to pay
$450,000 cash to acquire
Seller Company. Let’s look at the accounting.
Seller Company
Balance Sheet
At December 31, 2009
$ 500,000
Liabilities
Stockholders' Equity
Total
$ 100,000
400,000
$ 500,000
9-46

Goodwill
Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.
A-L=E
Seller Company
Balance Sheet
At December 31, 2009
$500,000 -$100,000
= $400,000
Assets $ 500,000
Liabilities
Stockholders' Equity
Total
$ 100,000
400,000
$ 500,000
$400,000 equity and you paid $450,000 =
$50,000 more than it is worth. This is
$50,000 Goodwill
Assets
Cash
(450,000)
+ Seller Assets
500,000
Goodwill
50,000
= Liab.
+ Equity
Seller Liab.
= 100,000 + NA
Rev.
– Exp.
= Net Inc.
NA – NA = NA
Cash Flow
(450,000) IA
9-47

Goodwill
Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.
Seller Company
Balance Sheet
At December 31, 2009
Assets $ 500,000
Liabilities
Stockholders' Equity
Total
$ 100,000
400,000
$ 500,000
Account Title
Seller Assets
Goodwill
Seller Liabilities
Cash
Debit
500,000
50,000
Credit
100,000
450,000
9-48

Expensing Intangible Assets
An asset with an identifiable useful life is amortized using the straightline method over the intangible’s legal life or its useful life. Assume we purchased a patent that has a
20-year legal and useful life for $20,000 cash.
Rev.
– Exp.
= Net Inc.
Cash Flow Assets = Liab.
+ Equity
Cash
(20,000)
NA
+ Patent
20,000
(1,000)
= NA +
NA
NA
(1,000)
NA
–
NA =
NA
–
1,000
NA
(1,000)
(20,000) IA
NA
Account Title
Patent
Cash
Amortization Expense - Patent
Patent
Debit
20,000
1,000
Credit
20,000
1,000
$20,000 / 20 =
$1,000
9-49

Intangible assets with indefinite useful lives must be tested for impairment annually. If the fair value of the intangible asset is less than its book value, an impairment loss is recognized.
Assume that at the end of 2008, we determine that goodwill has suffered a $10,000 impairment in value.
Rev.
– Exp.
= Net Inc.
Cash Flow Assets = Liab.
+ Equity
Goodwill
(10,000) = NA + (10,000) NA
–
10,000 = (10,000) NA
Account Title
Impairment Loss
Goodwill
Debit
10,000
Credit
10,000
9-50

Balance Sheet Presentation
9-51

LO 1
9-52

Assume that Alpha Company uses straight-line depreciation and Zeta Company uses the doubledecliningbalance method. Let’s look at their partial financial statements.
9-53

Assume that Alpha Company uses straight-line depreciation and Zeta Company uses the doubledecliningbalance method. Let’s look at their partial financial statements.
9-54

End of Chapter Nine
9-55