Directory UMM :wiley:Public:college:accounting:kimmel:
Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
S
EL
Chapter 9
Chapter 9
Reporting and Analyzing
Long-Lived Assets
After studying Chapter 9, you should be
able to:
Describe how the cost principle applies to plant assets.
Explain the concept of depreciation.
Compute periodic depreciation using the straight-line
method, and contrast its expense pattern with those of
other methods.
Describe the procedure for revising periodic
depreciation.
3
Chapter 9
Reporting and Analyzing
Long-Lived Assets
After studying Chapter 9, you should be
able to:
Explain how to account for the disposal of plant assets.
Describe methods for evaluating the use of plant assets.
Identify the basic issues related to reporting intangible
assets.
Indicate how long-lived assets are reported on the
balance sheet.
4
Plant Assets
Resources that:
have physical substance
are used in the operations of a business
are not intended for sale to customers
Recorded at cost
Cost consists of all expenditures
necessary to acquire the asset and
make it ready for its intended use.
5
Plant Assets
Land - a building site
Land improvements
driveway
parking lots
fences
underground sprinkler systems
Buildings
Equipment
6
Types of Expenditures
Revenue Expenditure immediately charged against
revenue as an expense
Capital Expenditure increase the company’s investment
in productive activity
7
Plant Assets
Cost is measured by:
the cash paid in a cash transaction, or
the cash equivalent price paid when noncash
assets are used in payment.
The cash equivalent price is equal to:
the fair market value of the asset given up, or
the fair market value of the asset received,
whichever is more clearly determinable.
8
Cost of Land Includes:
the cash purchase price
closing costs such as title and
attorney's fees
real estate brokers commissions
accrued property taxes and other liens
on the land assumed by the purchaser
9
Cost of Land
Improvements Include:
All expenditures necessary to make
the improvements ready for their
intended use
10
Cost of Buildings Include:
All necessary expenditures
relating to the purchase or
construction of a building.
When a building is purchased
such costs include the:
purchase price
closing costs (attorney's fees, title
insurance)
real estate broker's commissions.
11
Buildings
When a new building is constructed, its cost
consists of:
the contract price
architect's fees
building permits
excavation cost
interest costs during
construction.
12
Cost of Equipment Includes:
cash purchase price
sales tax
freight charges and insurance
during transit paid by the
purchaser
expenditures required in
assembling
installing and testing the unit
13
Equipment
Two criteria apply in determining the
cost of equipment:
the frequency of cost - one time or recurring
the benefit period - the life of the asset or 1 year
14
Depreciation
Applies to three classes of plant assets:
Land improvements
Buildings
Equipment
15
Depreciable Assets
The revenue-producing ability of an asset
declines during its useful life because of
wear and tear.
A decline in revenueproducing ability may also
occur because of obsolescence.
16
Page 390 in book
Depreciation
The process of allocating to expense the cost of a plant
asset over its useful life in a rational and systematic
manner.
A process of cost allocation, not a process of asset
valuation.
17
Land
Does not depreciate since its usefulness and
revenue producing ability generally remain
intact, or increase.
18
Accumulated Depreciation
The balance in accumulated depreciation is
not a cash fund.
S
CA
H
19
Factors in Computing
Depreciation
Cost - historical cost of the asset
Useful life - estimate of the expected
productive life in terms of:
time
units of out activity or output
Salvage value - an estimate of the asset's
value at the end of its useful life
20
Page 391 in book
Factors in Computing
Depreciation
Depreciation Methods
Straight-line
Declining-balance
Units-of-activity
22
Affects of Depreciation
Depreciation affects the balance sheet
through accumulated depreciation,
which is reported as a reduction from
plant assets.
Depreciation affects the income
statement through depreciation
expense.
23
Page 393 in book
Straight-Line Method
The most
widely used
method of
depreciation
Depreciation is
the same for
each year of the
asset's useful
life.
24
Straight-Line Method
Depreciable Cost*
The asset's useful life measured in
years
*cost of the asset less its salvage value
25
Straight-Line
Depreciation Formula
Page 393 in book
26
Partial Year Depreciation
If an asset is purchased during the
year rather than on January 1, the
annual depreciation is prorated
for the proportion of a year it is
used.
27
Page 394 in book
Declining-Balance Method
An accelerated
method
Accelerated methods
of depreciation
result in more
depreciation in the
early years of an
asset's life and less
depreciation in the
later years.
28
Page 394 in book
Units-of-Activity Method
The life of an
asset is
expressed in
terms of the total
units of
production or
the use expected
from the asset.
29
Page 392 in book
Use of
Depreciation
Methods in
Major U.S.
Companies
Depreciation and the IRS
The IRS allows corporate taxpayers to
deduct depreciation when computing
taxable income.
The IRS does not require the taxpayer
to use the same depreciation method on
the tax return that is used in preparing
financial statements.
31
Depreciation and the IRS
Many large corporations use straightline depreciation in their financial
statements to maximize net income.
At the same time they use a special
accelerated-depreciation method on
their tax returns to minimize their
income taxes.
32
Depreciation and the IRS
For tax purposes:
the straight-line method or
a special accelerated-depreciation method called
the
Modified
Accelerated
Cost
Recovery
System
The choice of depreciation method must be
disclosed in the notes to financial statements.
33
Revising Periodic Depreciation
When a change in an estimate is required,
the change is made in current and future
years but not to prior periods.
Significant changes in estimates must be
disclosed in the financial statements.
Extending an asset's estimated life reduces
depreciation expense and increases net
income for the period.
34
Ordinary Repairs
Expenditures to maintain the
operating efficiency and
expected productive life of the
asset.
Usually small in amount that
occur frequently throughout
the service life
35
Ordinary Repairs
Examples:
motor tune-ups
oil changes
the painting of buildings
the replacing of worn-out gears
Ordinary repairs increase Repair
Expense and are revenue expenditures.
36
Additions and Improvements
Costs incurred to increase the:
operating efficiency;
productive capacity; or
expected useful life of the plant asset.
Usually material in amount and occur
infrequently during the period of
ownership
Capital expenditures
37
Impairment
A permanent decline in the
market value of an asset
Written down to the new market
value during the year in which the
decline occurs.
38
Plant Asset Disposals
The depreciation for the fraction of the year to
the date of disposal must be recorded.
Depreciation Expense
Accumulated Depreciation
8,000
8,000
Compute Book Value:
Book Value =
Cost - Accumulated Depreciation
39
Sale of Plant Assets
In the sale of an asset, the book
value of the asset is compared
with the proceeds from the sale.
If the proceeds exceed the book
value a gain on disposal occurs.
Conversely, if proceeds from
the sale are less than the book
value a loss on disposal occurs.
40
Retirement of Plant Assets
Recorded by decreasing Accumulated
Depreciation for the full amount of
depreciation taken over the life of the asset.
The asset account is reduced for the
original cost of the asset.
The loss is equal to the asset's book value at
the time of retirement.
41
Analyzing Plant Assets
The three measures by which plant
assets are evaluated are:
Average useful life;
Average age of plant assets;
Asset turnover ratio.
42
Average Useful Life
Useful life of an assets is chosen by a
company
By selecting a longer estimated useful life:
A company spreads the cost of its plant assets
over a longer period of time;
The amount of expense reported in each period is
lower and net income is higher.
43
Average Useful Life
On the other hand, a shorter estimated
useful live will result in a lower reported
net income.
Average Useful Life of Plant Assets =
Average Cost of Plant Assets
Depreciation Expense
44
Average Age of Plant Assets
Most companies use straight-line
depreciation for financial reporting.
Average age of plant assets =
Accumulated Depreciation
Depreciation Expense
45
Asset Turnover Ratio
There are two ways a company can
increase its return on assets:
Increase profit per sale - measured by profit
margin ratio.
Increase its volume of sales - measured by
the asset turnover ratio =
Net Sales
Average Total Assets
46
Intangible Assets
rights
privileges
competitive advantages that result
from ownership of long-lived assets
that do not possess physical
substance
47
Amortization
Allocation of the cost of an intangible
asset to expense over the shorter of:
its useful (economic) life
its legal life
40 years
48
Types of Intangible Assets
Patents
Copyrights
Trademark or Trade Names
Franchises and Licenses
Goodwill
PATENT
49
Patents
An exclusive right issued by the U.S.
Patent Office that enables the
recipient to manufacture, sell, or
control a patent for 17 years from the
date of grant.
50
Patents
The initial cost of a patent is cash or
cash equivalent price paid to acquire
the patent.
Legal costs of protecting a patent in an
infringement suit are added to the
Patent account and amortized over the
remaining life of the patent.
51
Research and
Development Costs
Because of the uncertainty of
identifying the extent and timing of
future benefits, these costs are
usually recorded as an expense
when incurred.
52
Copyrights
Copyrights are granted by the federal
government giving the owner the
exclusive right to reproduce and sell
artistic or published work.
Copyrights extend for the life of the
creator plus 50 years.
53
Impressionist master
Pierre Renoir died in
1919…
therefore, anyone can
copy
A GIRL WITH A
WATERING CAN
or his other paintings
without receiving
permission or paying
a fee.
Trademarks/
Trade Names
A word, phrase,
jingle,or symbol that
distinguishes or
identifies a particular
enterprise or product.
Trademarks
Trade Names
Franchises
A franchise is a contractual agreement
under which the franchiser grants the
franchisee the right to:
sell certain products;
render specific services or to use certain
trademarks or trade names, usually within a
designated geographic area.
57
58
Licenses
Operating rights granted by a
government body permit the
enterprise to use public property in
performing its service (i.e., the use of
airwaves for radio or TV
broadcasting).
59
Costs Associated with
Franchise or License
When costs can be identified with the
acquisition of the franchise or license,
an intangible asset should be
recognized.
Annual payments made under a
franchise agreement should be
recorded as operating expenses.
60
Goodwill
Goodwill represents the value of all
favorable attributes that relate to a
business enterprise, including:
exceptional management
desirable location
good customer relations
skilled employees, etc.
61
Goodwill
Goodwill is recorded only when there
is an exchange transaction that
involves the purchase of an entire
business.
In other words, if you didn’t
buy it, it’s not on your balance
sheet.
62
Goodwill
When an entire business is
purchased, goodwill is the excess of
cost over the fair market value of
the net assets (assets less liabilities)
acquired.
63
Presentation Of
Long-Lived Assets
Plant assets are shown in the
financial statements under
Property, Plant, and Equipment.
Intangibles are shown
separately under
Intangible Assets.
64
COP Y R I GHT
Copyright © 1999, John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
65
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
S
EL
Chapter 9
Chapter 9
Reporting and Analyzing
Long-Lived Assets
After studying Chapter 9, you should be
able to:
Describe how the cost principle applies to plant assets.
Explain the concept of depreciation.
Compute periodic depreciation using the straight-line
method, and contrast its expense pattern with those of
other methods.
Describe the procedure for revising periodic
depreciation.
3
Chapter 9
Reporting and Analyzing
Long-Lived Assets
After studying Chapter 9, you should be
able to:
Explain how to account for the disposal of plant assets.
Describe methods for evaluating the use of plant assets.
Identify the basic issues related to reporting intangible
assets.
Indicate how long-lived assets are reported on the
balance sheet.
4
Plant Assets
Resources that:
have physical substance
are used in the operations of a business
are not intended for sale to customers
Recorded at cost
Cost consists of all expenditures
necessary to acquire the asset and
make it ready for its intended use.
5
Plant Assets
Land - a building site
Land improvements
driveway
parking lots
fences
underground sprinkler systems
Buildings
Equipment
6
Types of Expenditures
Revenue Expenditure immediately charged against
revenue as an expense
Capital Expenditure increase the company’s investment
in productive activity
7
Plant Assets
Cost is measured by:
the cash paid in a cash transaction, or
the cash equivalent price paid when noncash
assets are used in payment.
The cash equivalent price is equal to:
the fair market value of the asset given up, or
the fair market value of the asset received,
whichever is more clearly determinable.
8
Cost of Land Includes:
the cash purchase price
closing costs such as title and
attorney's fees
real estate brokers commissions
accrued property taxes and other liens
on the land assumed by the purchaser
9
Cost of Land
Improvements Include:
All expenditures necessary to make
the improvements ready for their
intended use
10
Cost of Buildings Include:
All necessary expenditures
relating to the purchase or
construction of a building.
When a building is purchased
such costs include the:
purchase price
closing costs (attorney's fees, title
insurance)
real estate broker's commissions.
11
Buildings
When a new building is constructed, its cost
consists of:
the contract price
architect's fees
building permits
excavation cost
interest costs during
construction.
12
Cost of Equipment Includes:
cash purchase price
sales tax
freight charges and insurance
during transit paid by the
purchaser
expenditures required in
assembling
installing and testing the unit
13
Equipment
Two criteria apply in determining the
cost of equipment:
the frequency of cost - one time or recurring
the benefit period - the life of the asset or 1 year
14
Depreciation
Applies to three classes of plant assets:
Land improvements
Buildings
Equipment
15
Depreciable Assets
The revenue-producing ability of an asset
declines during its useful life because of
wear and tear.
A decline in revenueproducing ability may also
occur because of obsolescence.
16
Page 390 in book
Depreciation
The process of allocating to expense the cost of a plant
asset over its useful life in a rational and systematic
manner.
A process of cost allocation, not a process of asset
valuation.
17
Land
Does not depreciate since its usefulness and
revenue producing ability generally remain
intact, or increase.
18
Accumulated Depreciation
The balance in accumulated depreciation is
not a cash fund.
S
CA
H
19
Factors in Computing
Depreciation
Cost - historical cost of the asset
Useful life - estimate of the expected
productive life in terms of:
time
units of out activity or output
Salvage value - an estimate of the asset's
value at the end of its useful life
20
Page 391 in book
Factors in Computing
Depreciation
Depreciation Methods
Straight-line
Declining-balance
Units-of-activity
22
Affects of Depreciation
Depreciation affects the balance sheet
through accumulated depreciation,
which is reported as a reduction from
plant assets.
Depreciation affects the income
statement through depreciation
expense.
23
Page 393 in book
Straight-Line Method
The most
widely used
method of
depreciation
Depreciation is
the same for
each year of the
asset's useful
life.
24
Straight-Line Method
Depreciable Cost*
The asset's useful life measured in
years
*cost of the asset less its salvage value
25
Straight-Line
Depreciation Formula
Page 393 in book
26
Partial Year Depreciation
If an asset is purchased during the
year rather than on January 1, the
annual depreciation is prorated
for the proportion of a year it is
used.
27
Page 394 in book
Declining-Balance Method
An accelerated
method
Accelerated methods
of depreciation
result in more
depreciation in the
early years of an
asset's life and less
depreciation in the
later years.
28
Page 394 in book
Units-of-Activity Method
The life of an
asset is
expressed in
terms of the total
units of
production or
the use expected
from the asset.
29
Page 392 in book
Use of
Depreciation
Methods in
Major U.S.
Companies
Depreciation and the IRS
The IRS allows corporate taxpayers to
deduct depreciation when computing
taxable income.
The IRS does not require the taxpayer
to use the same depreciation method on
the tax return that is used in preparing
financial statements.
31
Depreciation and the IRS
Many large corporations use straightline depreciation in their financial
statements to maximize net income.
At the same time they use a special
accelerated-depreciation method on
their tax returns to minimize their
income taxes.
32
Depreciation and the IRS
For tax purposes:
the straight-line method or
a special accelerated-depreciation method called
the
Modified
Accelerated
Cost
Recovery
System
The choice of depreciation method must be
disclosed in the notes to financial statements.
33
Revising Periodic Depreciation
When a change in an estimate is required,
the change is made in current and future
years but not to prior periods.
Significant changes in estimates must be
disclosed in the financial statements.
Extending an asset's estimated life reduces
depreciation expense and increases net
income for the period.
34
Ordinary Repairs
Expenditures to maintain the
operating efficiency and
expected productive life of the
asset.
Usually small in amount that
occur frequently throughout
the service life
35
Ordinary Repairs
Examples:
motor tune-ups
oil changes
the painting of buildings
the replacing of worn-out gears
Ordinary repairs increase Repair
Expense and are revenue expenditures.
36
Additions and Improvements
Costs incurred to increase the:
operating efficiency;
productive capacity; or
expected useful life of the plant asset.
Usually material in amount and occur
infrequently during the period of
ownership
Capital expenditures
37
Impairment
A permanent decline in the
market value of an asset
Written down to the new market
value during the year in which the
decline occurs.
38
Plant Asset Disposals
The depreciation for the fraction of the year to
the date of disposal must be recorded.
Depreciation Expense
Accumulated Depreciation
8,000
8,000
Compute Book Value:
Book Value =
Cost - Accumulated Depreciation
39
Sale of Plant Assets
In the sale of an asset, the book
value of the asset is compared
with the proceeds from the sale.
If the proceeds exceed the book
value a gain on disposal occurs.
Conversely, if proceeds from
the sale are less than the book
value a loss on disposal occurs.
40
Retirement of Plant Assets
Recorded by decreasing Accumulated
Depreciation for the full amount of
depreciation taken over the life of the asset.
The asset account is reduced for the
original cost of the asset.
The loss is equal to the asset's book value at
the time of retirement.
41
Analyzing Plant Assets
The three measures by which plant
assets are evaluated are:
Average useful life;
Average age of plant assets;
Asset turnover ratio.
42
Average Useful Life
Useful life of an assets is chosen by a
company
By selecting a longer estimated useful life:
A company spreads the cost of its plant assets
over a longer period of time;
The amount of expense reported in each period is
lower and net income is higher.
43
Average Useful Life
On the other hand, a shorter estimated
useful live will result in a lower reported
net income.
Average Useful Life of Plant Assets =
Average Cost of Plant Assets
Depreciation Expense
44
Average Age of Plant Assets
Most companies use straight-line
depreciation for financial reporting.
Average age of plant assets =
Accumulated Depreciation
Depreciation Expense
45
Asset Turnover Ratio
There are two ways a company can
increase its return on assets:
Increase profit per sale - measured by profit
margin ratio.
Increase its volume of sales - measured by
the asset turnover ratio =
Net Sales
Average Total Assets
46
Intangible Assets
rights
privileges
competitive advantages that result
from ownership of long-lived assets
that do not possess physical
substance
47
Amortization
Allocation of the cost of an intangible
asset to expense over the shorter of:
its useful (economic) life
its legal life
40 years
48
Types of Intangible Assets
Patents
Copyrights
Trademark or Trade Names
Franchises and Licenses
Goodwill
PATENT
49
Patents
An exclusive right issued by the U.S.
Patent Office that enables the
recipient to manufacture, sell, or
control a patent for 17 years from the
date of grant.
50
Patents
The initial cost of a patent is cash or
cash equivalent price paid to acquire
the patent.
Legal costs of protecting a patent in an
infringement suit are added to the
Patent account and amortized over the
remaining life of the patent.
51
Research and
Development Costs
Because of the uncertainty of
identifying the extent and timing of
future benefits, these costs are
usually recorded as an expense
when incurred.
52
Copyrights
Copyrights are granted by the federal
government giving the owner the
exclusive right to reproduce and sell
artistic or published work.
Copyrights extend for the life of the
creator plus 50 years.
53
Impressionist master
Pierre Renoir died in
1919…
therefore, anyone can
copy
A GIRL WITH A
WATERING CAN
or his other paintings
without receiving
permission or paying
a fee.
Trademarks/
Trade Names
A word, phrase,
jingle,or symbol that
distinguishes or
identifies a particular
enterprise or product.
Trademarks
Trade Names
Franchises
A franchise is a contractual agreement
under which the franchiser grants the
franchisee the right to:
sell certain products;
render specific services or to use certain
trademarks or trade names, usually within a
designated geographic area.
57
58
Licenses
Operating rights granted by a
government body permit the
enterprise to use public property in
performing its service (i.e., the use of
airwaves for radio or TV
broadcasting).
59
Costs Associated with
Franchise or License
When costs can be identified with the
acquisition of the franchise or license,
an intangible asset should be
recognized.
Annual payments made under a
franchise agreement should be
recorded as operating expenses.
60
Goodwill
Goodwill represents the value of all
favorable attributes that relate to a
business enterprise, including:
exceptional management
desirable location
good customer relations
skilled employees, etc.
61
Goodwill
Goodwill is recorded only when there
is an exchange transaction that
involves the purchase of an entire
business.
In other words, if you didn’t
buy it, it’s not on your balance
sheet.
62
Goodwill
When an entire business is
purchased, goodwill is the excess of
cost over the fair market value of
the net assets (assets less liabilities)
acquired.
63
Presentation Of
Long-Lived Assets
Plant assets are shown in the
financial statements under
Property, Plant, and Equipment.
Intangibles are shown
separately under
Intangible Assets.
64
COP Y R I GHT
Copyright © 1999, John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
65