Accounting Fundamentals
Dr. Yan Xiong
Department of Accountancy
CSU Sacramento
The lecture notes are primarily based on Reimers
(2003).
7/11/02
Chapter 5: Acquisitions
Agenda




Acquisition costs of long-term assets
Depreciation
Asset Disposal
Depletion and Amortization
Classification of Operational Assets


Operational assets are assets used by a
business to generate revenue.
Difference between Operational
assets and Inventory
Agenda

Acquisition Costs of Long-term
Assets
Long-term Operational Assets...



Long-term assets will be used more than
one year.
Tangible operational assets have physical
substance.
Land, buildings, fixtures, and equipment
Natural resources
Tangible operational assets are reported
on the balance sheet in a classification
called Property, Plant, and Equipment.
Classification of Operational Assets

Intangible operational assets lack
physical substance and confer specific
use rights on the owner.
Patents
Copyrights
Franchises
Licenses
Trademarks
Measuring and Recording Acquisition Cost
Purchased operational assets are recorded at
cost, an amount that includes all normal and
reasonable expenditures necessary to get the
asset in place and ready for its intended use.
Invoice price
Sales taxes
Transportation costs
Installation costs
Renovation and repair cost incurred
prior to use.
Measuring Acquisition Cost

Financing charges are excluded from
the acquisition cost but should be
reported as interest expense.
Basket Purchase of Acquisitions
When land and building are purchased
together, the land cost and the building
cost are placed in separate accounts.
The total cost of the purchase is separated
on the basis of relative market values.
Basket Purchase of Acquisitions
Example: On March 1, Arco Co. purchased
land and building for $200,000 cash. The
appraised value of the building was $172,500,
and the land was appraised at $57,500. How
much of the $200,000 purchase price will be
allocated to each account?
Basket Purchase of Acquisitions
Fair Market Values:
Building
Land
$ 172,500
$ 57,500
Total market value
$ 230,000
Allocation of cost:
Building
Land
* $200,000 =
* $200,000 =
Basket Purchase of Acquisitions
Fair Market Values:
Building
Land
$ 172,500
$ 57,500
Total market value
$ 230,000
Allocation of cost:
Building
Land
172,500/230,000 * $200,000 =
57,500/230,000 * $200,000 =
Basket Purchase of Acquisitions
Fair Market Values:
Building
Land
$ 172,500
$ 57,500
Total market value
$ 230,000
Allocation of cost:
Building
Land
.75 * $200,000 = 150,000
.25 * $200,000 = 50,000
Basket Purchase of Acquisitions

How would the acquisition of the land and
building be recorded in the journal?
Date
Transaction
Debit
Mar 1
Land
Building
Cash
50,000
150,000
Credit
200,000
Agenda

Depreciation
Nature of Depreciation, Depletion, and
Amortization
The matching principle requires that part of the
acquisition cost be expensed in periods when
the future revenues are earned.
Cost of asset
on Balance
Sheet
[capitalize]
...as the asset
is used.....
Expense on
Income
Statement
[expense]
Terminology: Write-off….amortize
The most general term for writing off an asset is
amortization. However, specific terms are used for
certain assets:
 Depreciation:
 Amortization:
Property,
plant,
equipment
Intangible
assets

franchise
Depletion:
–Natural resources
Depreciation Methods
 Straight-line
 Production method
 (Double) Declining balance
Straight-Line Method
Depreciation
Expense per Year
=
Cost - Residual Value
Life in Years
Straight-Line Method: Example
On January 1, 2003, equipment was
purchased for $55,000 cash. The
equipment has an estimated useful
life of 5 years and an estimated
residual value of $10,000.
What is the annual straight-line
depreciation expense?
Straight-Line Method: Example
Depreciation
Expense per Year
Depreciation
Expense per Year
Depreciation
Expense per Year
=
=
Cost - Residual Value
Life in Years
55,000 - 10,000
5
=
9,000
Straight-Line Method: Example
Calculate depreciation expense for the
fourth year of the asset’s life.
$9000
Depreciation expense is the same
amount each year of the asset’s life
using the straight-line method.
Straight-Line Method: Example

How would each year’s depreciation be
recorded in the journal?
Date
Transaction
Debit Credit
Dec 31 Depreciation expense
9,000
Accumulated depreciation
9,000
Units-of-Production Method
Step 1:
Depreciation
Rate
=
Cost - Residual Value
Estimated units of useful life
=
Number of
Depreciation
× Units Produced
Rate
for the Year
Step 2:
Depreciation
Expense
Units of Production Method:
Example
Given the same information [asset cost
$55,000, a residual value of $10,000, and a
useful life of five years] plus the asset is
estimated to have a total productive capacity
of 100,000 units during the useful life:
If 22,000 units were produced this year, what is
the amount of depreciation expense?
Production Method: Example
Step 1:
Depreciation =
Rate
Cost – Residual value
45,000
=
Estimated Units produced
100,000
Step 2:
Dep. rate * units produced
Depreciation
= $ .45/unit * 22,000
=
Expense
9,900
Production Method: Example

How would the first year’s depreciation be
recorded in the journal?
Date
Transaction
Debit Credit
Dec 31 Depreciation expense
9,900
Accumulated depreciation
9,900
Production Method: Example

If 15,000 units are produced during
the second year of the asset’s life,
what is the amount of depreciation
expense?
.45 * 15000 =
6750
Production Method: Example

How would the second year’s depreciation
be recorded in the journal?
Date
Transaction
Debit Credit
Dec 31 Depreciation expense
6,750
Accumulated depreciation
6,750
Accelerated Depreciation

Accelerated depreciation methods
result in more depreciation expense in
the early years of an asset’s useful life
and less depreciation expense in later
years of the an asset’s useful life.
Double-Declining Balance Method

Declining-balance depreciation is
based on the straight-line rate
multiplied by an acceleration factor.
For
example, when the
acceleration factor is 200
percent, the method is referred
to as double-declining balance
depreciation.

Declining-balance depreciation
computations ignore residual value,
although the asset can’t be depreciated
below the residual value.
Double-Declining Balance Method
First, calculate a rate by dividing 2 by the number
of years of useful life.
The annual depreciation amount is
calculated with the following formula:
Book Value × (2 / useful life in years)
=
Double-Declining Balance Method
Annual depreciation expense is
calculated with
the following formula:
2
Book Value ×
(
Useful Life in Years
)
Double-Declining-Balance Example
Using the same information from our
earlier example [asset cost $55,000,
residual value is $10,000, and useful life
is 5 years]:
Calculate the depreciation expense
for the first two years of the asset’s life.
Double-Declining-Balance Example
Rate = 2/5 = 40%
First year’s depreciation:
55,000 * .40 =
22,000
Double-Declining-Balance Example

How would the first year’s depreciation be
recorded in the journal?
Date
Transaction
Debit Credit
Dec 31 Depreciation expense
22,000
Accumulated depreciation
22,000
Double-Declining-Balance Example
Rate = 2/5 = 40%
First year’s depreciation:
55,000 * .40 =
22,000
Second year’s depreciation:
33,000 * .40 =
13,200
Double-Declining-Balance Example

How would the second year’s depreciation
be recorded in the journal?
Date
Transaction
Debit Credit
Dec 31 Depreciation Expense
13,200
Accumulated Depreciation
13,200
Comparison of Methods



The total amount of depreciation recorded
over the useful life of an asset is the same
regardless of the method used.
Depreciation expense recorded in any one
period will vary according to method used.
The straight-line method is used by about
95 percent of companies because it is
easy to use and to explain.
Revising Estimates of Salvage
Value or of Useful Life



When an estimate is revised, no changes
are made to amounts reported in the
past.
The new estimates are incorporated into
the present and future calculations only.
Depreciation amounts are revised using
the book value and the estimated useful
life and salvage value at beginning of the
year of the revision.
Continuing Expenditures
for Plant Assets


Expenditures made to keep
an asset in good working
order are expensed in the
period in which they are
incurred.
Substantial costs spent to
improve the quality or
extend the life of an asset
are capitalized.
Agenda

Asset Disposal
Disposal of Operational Assets

Voluntary disposal refers to
situations where a business gives up
ownership of an asset by:
Sale
Trade-in
Retirement

Involuntary disposal results because
of a casualty such as a fire or an
accident.
Disposal of Operational Assets
1. Update the depreciation on the asset to
the date of disposal.
2. Compare the book value of the asset to the
cash proceeds from the disposal. If the
proceeds > book value, there is a gain on
the disposal. If the book value > proceeds,
then there is a loss on the sale.
3. Gains and losses go on the income
statement.
Asset Disposal: Example

On Jun 1, a Truck
which was purchased
for $10,000 and with
accumulated
depreciation of
$8,000 was sold for
$3,000.




Compare the Book Value (10,000-8,000)
to the cash proceeds (3,000).
The difference is a gain or loss on the
sale.
This sale results in a gain:
Proceeds of $3,000 > BV of $2,000
Gain of $1,000 goes to the income
statement.
Asset Disposal: Gain recognized

How would the sale of the truck be
recorded in the journal?
Date
Transaction
Debit Credit
Jun 1 Cash
Accumulated depreciation
Gain on sale of truck
3,000
8,000
1,000
Truck
10,000
Asset Disposal: Example

On Jun 1, a Truck
which was purchased
for $10,000 and with
accumulated
depreciation of
$8,000 was sold for
$1,000.
Compare the Book Value (10,000-8,000) to
the cash proceeds (1,000).
 The difference is a gain or loss on the sale.
 Here the sale results in a loss:
Book value of $2,000 > Proceeds of
$1,000
 Loss on disposal of $1,000 goes to the
income statement.

Asset Disposal: Loss recognized

How would the sale of the truck be
recorded in the journal?
Date
Transaction
Jun 1 Cash
Accumulated depreciation
Loss on sale of truck
Truck
Debit Credit
1,000
8,000
1,000
10,000
Disposal of Operational Assets
Compare cash received for the asset with
the asset’s book value (BV).
If
cash greater than BV, record a gain.
If cash less than BV, record a loss.
If cash equals BV, no gain or loss.
Agenda

Depletion and Amortization
Natural Resources



Assets supplied by nature
Examples: gold, oil, and coal
Presented on balance sheet as
non-current assets at cost less
depletion to date.
Depletion is just like “units of
production” depreciation.
Natural Resources


Total cost of the asset is the cost of
acquisition, exploration and development.
Total cost is apportioned by means of
depletion over periods in which resulting
revenues are earned.
Natural Resources
A depletion rate is calculated using
the units-of-production method.
Depletion Cost Per Unit Is Calculated As Follows:
Total Cost of Natural Resource
Estimated Number of Available Units
of Natural Resource
Intangible Assets

Noncurrent assets without physical
substance that confer certain rights and
privileges on the owner of the asset.
Examples:
patents, copyrights,
franchises and licenses, leaseholds,
leasehold improvements, trademarks,
and goodwill.

Purchased intangible assets are recorded
at cost.
Intangible Assets


Purchased intangible assets are amortized over
the shorter of their economic life or legal life,
subject to a maximum of 40 years.
Normally the straight-line method is used and
the asset is reported in the balance sheet at
book value without a related accumulated
amortization account.
Intangible Assets: Patents


A patent is an exclusive right granted by
federal government to sell or
manufacture an invention.
A patent is amortized over the shorter of
its useful life or 17-year legal life.