Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

1. Fundamental Financial Accounting ConceptsFourth EditionbyEdmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

2. 9- 2 Chapter 9 Long-Term Operational Assets

3. 9- 3 Classification of Operational Assets Operational assets are used by a business to generate revenue. Tangible operational assets have physical substance. Land, buildings, fixtures, and equipment Natural resources

4. 9- 4 Long-term Operational Assets... Long-term assets will be used more than one year. Tangible operational assets are reported on the balance sheet in a classification called Property, Plant, and Equipment.

5. 9- 5 Classification of Operational Assets Intangible operational assets lack physical substance and confer specific use rights on the owner. Patents Copyrights Franchises Licenses Trademarks

6. 9- 6 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 and Recording Acquisition Cost

7. 9- 7 Measuring Acquisition Cost Acquisition cost is the net cash equivalent amount paid for the asset. Financing charges are excluded from the acquisition cost but should be reported as interest expense.

8. 9- 8 The cost of land includes: Acquisition price Real estate commissions Title search and transfer fees Title insurance premiums Delinquent taxes Surveying fees Land is not depreciated. Measuring Acquisition Cost

9. 9- 9 Basket Purchases of Assets 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.

10. 9- 10 Example: On March 1, Arco Co. purchasedland and building for $100,000 cash. The appraised value of the building was $90,000 and the land was appraised at $30,000. How much of the $100,000 purchase price will be allocated to each account? Land = ? Building = ? Basket Purchases of Assets

11. 9- 11 Basket Purchases of Assets

12. 9- 12 Basket Purchases of Assets

13. 9- 13 Basket Purchases of Assets

14. 9- 14 Basket Purchases of Assets

15. 9- 15 Basket Purchases of Assets

16. 9- 16 Basket Purchases of Assets

17. 9- 17 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.

18. 9- 18 Terminology: Write-off….amortize Amortization: Intangible assets Depreciation: Property, plant, equipment

19. 9- 19 Depreciation Methods For Financial Accounting (books) Straight-line Production method (Double) Declining balance

20. 9- 20

21. 9- 21 Straight-Line Method: Example On January 1, 2004, 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?

22. 9- 22 Straight-Line Method: Example

23. 9- 23 Straight-Line Method: Example

24. 9- 24 Straight-Line Method: Example

25. 9- 25 Calculate depreciation expense for the second year of the asset’s life. 9,000 Depreciation expense is the same amount each year of the asset’s life using the straight-line method. Straight-Line Method: Example

26. 9- 26 Units-of-Production Method

27. 9- 27 Units-of-Production Method

28. 9- 28  Given the same information [asset cost $55,000, has a residual value of $10,000, has a useful life of five years] plus the fact that 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?

29. 9- 29 Example of Production Method

30. 9- 30 Example of Production Method

31. 9- 31 Example of Production Method If 15,000 units are produced during the second year of the asset’s life, what is the amount of depreciation expense? $ What is the Accumulated Depreciation at the end of the second year? $ What is the 12/31/05 Equip. Book Value? $

32. 9- 32 Example of Production Method If 15,000 units are produced during the second year of the asset’s life, what is the amount of depreciation expense? $0.45 x 15,000 = $6,750 What is the Accumulated Depreciation at the end of the second year? $9,900 + $6,750 = $16,650 What is the 12/31/05 Equip. Book Value? $55,000 cost - $16,650 Accum. Dep. = $38,350

33. 9- 33 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. Accelerated Depreciation

34. 9- 34 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.

35. 9- 35 Double-Declining Balance Method

36. 9- 36 Double-Declining-Balance Method

37. 9- 37 Double-Declining-Balance Example

38. 9- 38 Double-Declining-Balance Example

39. 9- 39 Double-Declining-Balance Example

40. 9- 40 Double-Declining-Balance Example

41. 9- 41 Comparison of Depreciation Methods

42. 9- 42 Comparison of Depreciation Methods

43. 9- 43 Comparison of Depreciation 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 for financial accounting purposes (“the books”) by about 95 percent of companies because it is easy to use and to explain to financial statement users.

44. 9- 44 Horizontal Model TransactionsDepreciation and Disposal

45. 9- 45 Horizontal Model Transaction Analysis

46. 9- 46 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B

47. 9- 47 What’s the result? - End of Year 1

48. 9- 48 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B ..

49. 9- 49 What’s the result? - End of Year 1

50. 9- 50 Horizontal Model TransactionsDepreciation and Disposal

51. 9- 51 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B ..

52. 9- 52 What’s the result? - End of Year 2

53. 9- 53 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B

54. 9- 54 What’s the result? - End of Year 2

55. 9- 55 Disposal of Operational Assets

56. 9- 56 Horizontal Model TransactionsDepreciation and Disposal

57. 9- 57 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.

58. 9- 58 1. Update the depreciation on the asset to the date of disposal. (Jan.1-Sept 1 = 8 mo.) Disposal of Operational Assets

59. 9- 59 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B ..

60. 9- 60 1. Update the depreciation on the asset to the date of disposal. 2. Record the disposal by . . . Removing the asset cost (credit). Removing the Accumulated Depreciation (debit). Recording cash received (debit) or cash paid (credit). Recording a loss (debit) or gain (credit). Disposal of Operational Assets

61. 9- 61 Compare cash received for the asset with the asset’s book value (BV). If cash greater than BV, record a gain (credit). If cash less than BV, record a loss (debit). If cash equals BV, no gain or loss. Gain or Loss on Disposal?

62. 9- 62 Compare cash received for the asset with the asset’s book value (BV). Disposal of Operational Assets

63. 9- 63 Compare cash received for the asset with the asset’s book value (BV). Disposal of Operational Assets

64. 9- 64 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B

65. 9- 65 Journalize the Disposal

66. 9- 66 Journalize the Disposal

67. 9- 67 Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000) IA 3 30,000 30000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B 6 6,000 (6000) 6,000 (6000) 7 26,000 (55,000) (24,000) (5000) 5,000 (5000) 26,000 IA ..

68. 9- 68 What’s the result? - For Year 3

69. 9- 69 What’s the result? - For Year 3

70. 9- 70 Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. (Could use straight-line depreciation.) MACRS provides for rapid write-off of an asset’s cost in order to stimulate investment in modern facilities. MACRS uses half-year convention and assumes no residual value. Depreciation and Federal Income Tax

71. 9- 71 Same purchase recorded previously: On Jan. 1, 2004 equipment costing $55,000 was purchased. Estimated life = 5 yrs. Estimated residual value = $10,000. Depreciation and Federal Income TaxMACRS example

72. 9- 72 IRS Table yr. % 1 20.00 2 32.00 3 19.20 4 11.52 5 11.52 6 5.76 Depreciation and Federal Income TaxMACRS example

73. 9- 73 IRS Table yr. % 1 20.00 2 32.00 3 19.20 4 11.52 5 11.52 6 5.76 Depreciation and Federal Income TaxMACRS example

74. 9- 74 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, estimated useful life and salvage value at beginning of the year of the revision.

75. 9- 75 Revising Estimates of Salvage Value or of Useful Life - Example

76. 9- 76 Revising Estimates of Salvage Value or of Useful Life - Example

77. 9- 77 Revising Estimates of Salvage Value or of Useful Life - Example

78. 9- 78 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. (normally expected repairs & maintenance) Substantial costs spent to improve the quality or extend the life of an asset are capitalized.

79. 9- 79 Accounting for capital expenditures: Extraordinary Repairs Ex: Overhaul Extend the life? viewed as canceling some of the previous depreciation journal entry to reduce (debit) accumulated depreciation new depreciation amount will be calculated using the revision approach. Betterments Ex: Attach snowplow to truck owned for 2 years. Improve the quality? viewed as an additional cost of the equipment journal entry to increase (debit) the cost of the asset new depreciation amount will be calculated using the revision approach.

80. 9- 80 Natural Resources Assets supplied by nature Examples: gold, oil, and coal Presented on balance sheet as non-current assets at cost minus all depletion to date. Total cost of the asset is the cost of acquisition, exploration and development. Cost is “written-off” as “Depletion Expense” over periods that related revenues are earned. (Usually, units-of-production method.)

81. 9- 81 Natural Resources

82. 9- 82 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.

83. 9- 83 Two Categories of Intangible Assets Intangible assets with IDENTIFIABLE useful lives. e.g. Patents and Copyrights They have a legal life, BUT they MAY become obsolete or worthless before their legal live is over. Intangible assets with INDEFINITE useful lives. e.g. Goodwill, Franchise, Trademark How long will the “name” of a restaurant keep attracting customers if new owners don’t serve good food and provide good service?

84. 9- 84 Intangible Assets with IDENTIFIABLE Useful Lives Amortize (write-off) over the shorter of their useful life or legal life. Normally the straight-line method is used and the asset is reported on the balance sheet at book value without a related accumulated amortization account.

85. 9- 85 Intangible Assets: Patents A patent is an exclusive right granted by the federal government to sell or manufacture an invention. A patent is amortized over the shorter of its useful life or 17-year legal life.

86. 9- 86 Intangible Assets with IDENTIFIABLE Useful Lives Example: (1) A patent is purchased from a company for $20,000. (2) When purchased, there were 15 years remaining of the 17 year legal life, but management estimates that new technology will make this patent obsolete in 4 years. ($20,000/4=$5,000)

87. 9- 87 Intangible Assets with INDEFINITE Useful Lives Must be tested for IMPAIRMENT each year. If the fair market value of the intangible asset is less than its book value, the value has been IMPAIRED (reduced). To reduce the intangible asset to its new lower fair value an IMPAIRMENT LOSS is recorded and reported on the Income Statement. The intangible asset is reduced by the same amount.

88. 9- 88 Intangible Assets: Goodwill Goodwill is the added value of a business that is attributable to favorable factors such as a good reputation, location, and superior products. Goodwill must be PURCHASED by acquiring an existing business at a cost that is higher than the Fair Market Value of its physical assets (minus any liabilities assumed by the buying company). Goodwill has an INDEFINITE useful life, so it must be tested for IMPAIRMENT each year.

89. 9- 89 Intangible Assets: Goodwill (Example) Winona Co. purchased Rushford Co. by paying $1,500 cash for all of its assets, but also agreeing to assume its liabilities. Individual company balance sheets before purchase: Rushford Co. Winona Co. Assets: Liab.-A/P 200 Assets: Liab.-A/P 1000 Eq.,net 1000 C.Cap. 500 Cash 2000 C.Cap. 3000 Ret.Earn 300 Eq.,net 7000 Ret.Earn 5000 T. Assets 1000 T. L&Eq.1000 T.Assets 9000 T. L&Eq. 9000 An appraiser says the Fair Market Value of Rushford’s assets is $1,300.

90. 9- 90 Intangible Assets: Goodwill (example)

91. 9- 91 Intangible Assets: Goodwill (example)

92. 9- 92 Horizontal Model Transaction Analysis

93. 9- 93 Horizontal Model Transaction Analysis

94. 9- 94 Chapter 9