Long-Term Assets: Plant Assets and Intangibles

1. Long-Term Assets: Plant Assets and Intangibles Chapter 9 Part 1

2. Objective 1 Define and describe the life cycle of long-term assets

3. Long-lived Assets Plant Assets Natural Resources Intangible Assets Depreciation Depletion Amortization

4. Internal Controls • All plant assets should be labeled • Maintain a subsidiary ledger • Reconcile the total balance of subsidiary accounts with the controlling account • Physically inspect each asset at least once a year

5. Objective 2 Calculate and record the cost to acquire plant assets

6. Cost Principle • Assets should be recorded at their historical cost • Cost of an asset – all costs necessary to acquire the asset and get it ready for its intended use • Also includes • costs to improve the asset • Costs to extend life of the asset • Does NOT include repairs and maintenance that are anticipated as normal period costs

7. Land Purchase price Legal fees Costs of grading and clearing Additional permanent improvements Not depreciated Land Improvements - Improvements with limited life Driveways and parking lots Sidewalks Fences Depreciated Land and Land Improvements

8. Buildings • Purchase price • Legal fees • Repairs and renovations • If self-constructed • Architectural fees • Building permits • Material • Labor • Overhead • Some interest costs

9. Machinery and Equipment • Purchase price (less any discounts) • Transportation charges • Insurance while in transit • Sales tax • Installation costs • Cost of testing before asset is used

10. Furniture and Fixtures • Purchase price (less any discounts) • Shipping charges • Costs to assemble

11. Land Purchase price $200,000 Property tax 2,100 Title insurance 2,500 Remove and level 10,400 $215,000 Building Cost $800,000 Land improvements Fence $51,000 Signage 15,000 Lighting 6,000 $72,000 E9-14

12. Lump Sum Purchases • Assign cost to individual assets based on relative sales values • For example: Cost to build 3 items is $10,000. How do we allocate this cost to the individual items?

13. E9-16 $2,500 25.0% $3,000/$12,000 $5,000/$12,000 4,170 41.7% 3,330 33.3% $4,000/$12,000 $10,000 100%

14. E9-16 $2,500 25.0% 4,170 41.7% 3,330 33.3% $10,000 100%

15. E9-16 Bed 1 2,500 Bed 2 4,170 Bed 3 3,330 Cash 5,000 Note Payable 5,000

16. Capital Expenditures Does the expenditure increase capacity or efficiency or extend useful life? YES NO Capital Expenditure Debit asset account Expense Debit repairs and maintenance expense

17. E9-16 Expenditure benefits more than one period. Debit an asset Capital Expenditures • Purchase price • Lubrication before machine is placed in service • Major overhaul • Sales tax • Transportation and insurance • Installation • Training of personnel Expenses: • Ordinary recurring repairs • Periodic lubrication • Income tax Expenditure that maintains the asset in its current working condition. Debit an expense

18. Objective 3 Calculate and record depreciation of plant assets

19. Depreciation • Process of allocating the cost of a plant asset to expense over its useful life in a rational and systematic way Matching Principle

20. POINT • We are spreading the expense of purchasing an asset (its cost) over time (period usually = year, quarter, or month) • We are NOT estimating the fair market value

21. Example • Example: Purchase a machine for $1,000 in year 1 that will last 5 years. Make income every year for $1,000 a year for the next 5 years.

22. Illustration

23. Depreciation – Adjusting Entry Partial balance sheet: Building $120,000 Less Accumulated Depreciation (80,000) $40,000 Depreciation Expense Accumulated Depreciation

24. Factors in Computing Depreciation • Cost • Estimated Residual Value (what asset is worth at end of life…salvage) • Depreciable cost = Cost – Residual Value • Estimated Useful Life • Physical wear and tear • Obsolescence

25. Depreciation Methods • Straight-line • Units-of-production • Declining balance

26. Depreciation Expense per Year Cost - Residual ValueUseful life in years = Straight-Line Method

27. E9-19 Straight-line $30,000 – $6,000 / 4 years = $6,000 per yr $24,000 $6,000 $6,000 18,000 6,000 12,000 6,000 18,000 12,000 6,000 24,000 6,000

28. Units-of-Production Method 1: Compute depreciation per unit: Cost - Residual Value Total Units of Production 2: Compute depreciation expense: Depreciation per unit Number of units producedin the period ×

29. E9-19 Units of Production ($30,000 - $6,000) / 1,000 operations = $24.00 per operation $2,400 $24 x 100 7,200 $24 x 300 $24 x 400 9,600 $24 x 200 4,800

30. E9-19 Units of Production ($30,000 - $6,000) / 1,000 operations = $24.00 per operation $2,400 $27,600 $2,400 7,200 20,400 9,600 19,200 10,800 9,600 24,000 6,000 4,800

31. Double-Declining Balance Method • Accelerated method – writes off a greater amount of the cost of an asset in earlier years of asset’s useful life • Amount of depreciation expense recognized declines each year • Cheryl’s observation • Rationale had nothing to do with logic • Rationale was politically driven • Now, IRS just says what you can take (and it is a lot in the first years)

32. 1 Useful life in years X 2 Depreciationexpense Double-declining-balance rate Beginning periodbook value = × Ignores residual value Double-Declining-Balance Method 1: Compute straight-line rate and multiply it by 2 2: Multiply beginning book value by rate

33. Switchover to Straight Line • A method employed by some companies • Change from double-declining balance to straight-line during the next-to-last year of asset’s life • Eliminates the need to use a plug figure for depreciation expense in last year

34. E9-19 Double declining Balance: Life = 4 years Rate = 2 * 1/4 or 50% $30,000 x 50% $15,000 $15,00 x 50% 7,500 ($7,500 – 6,000)/2 750 750

35. E9-19 Double declining Balance: Cost = $30,000, Life = 4 years Rate = 2 * 1/4 or 50% $30,000 x 50% $15,000 $15,000 $15,000 $15,00 x 50% 22,500 7,500 7,500 750 ($7,500 – 6,000)/2 23,250 6,750 750 24,000 6,000 750

36. Use of Depreciation Methods

37. Partial Year Depreciation • When plant asset is acquired during the year, compute full year’s depreciation and multiply that by the fraction of the year the asset is owned

38. – Book value New residual value Revising Depreciation • Depreciation is an estimate • Estimated residual value • Estimated useful life Remaining life in years

39. E9-20 Cost $700,000 Residual value 100,000 Depreciable base $600,000 /40 years Depreciation expense per year $15,000

40. E9-20 Depreciation expense per year $15,000 X 15 years Accumulated depreciation after 15 years $225,000

41. E9-20 Book value after 15 years Cost $700,000 Accumulated depreciation (225,000) Cost left to depreciate $475,000 Residual value (Changed)(175,000) New depreciable base $300,000 Life (30 years – 15 years taken) /15 year New depreciation per year $20,000

42. E9-20 Yr 15 Depreciation Expense 15,000 Accumulated Depreciation 15,000 Yr 16 Depreciation Expense 20,000 Accumulated Depreciation 20,000

43. Fully Depreciated Assets • If still useful, a company will continue to use it • Report book value on balance sheet • Record no more depreciation

44. Depreciation for Tax Reporting • Modified Accelerated Cost Recovery System (MACRS) • Assets are classified into categories by asset life • Depreciation method is specified according to category