8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

1/44

TANGIBLE ASSETSWAYBRIGHT & KEMPLIBBY, LIBBY & SHORT

CHAPTER 8

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

2/44

Classifying Long-Lived Assets

8-2

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Expected to Benefit Future Periods

Actively Used in Operations

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

3/44

Classifying Long-Lived Assets

8-3

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Expected to Benefit Future Periods

Actively Used in Operations

Land Assets subject todepreciation

Buildings and equipment

Furniture and fixtures

Natural resource assetssubject to depletion

Mineral deposits and timber

Examples

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

4/44

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

5/44

COST PRINCIPLE?

GAAP ?

IFRS ?

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

6/44

Measuring and RecordingAcquisition Cost

Acquisition cost includes the purchase priceand all expenditures needed to prepare the

asset for its intended use.

Acquisition cost does notincludefinancing charges and cash discounts.

8-6

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

7/44

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

8/44

Acquisition Cost

Equipment

8-8

Purchase price Installation costs

Modification to building

necessary to installequipment

Transportation costs

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

9/448-9

Purchase price

Real estate commissions

Title insurance premiums

Unpaid taxes owed on the land

Surveying fees

Title search and transfer fees

Cost of clearing & removing unwantedbuilding

Acquisition CostLand

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

10/44

8-10

Fencing

Paving

Sprinkler system

Lighting

Sign

Cost of LandDOES NOTINCLUDE

Known as land improvementsseparate account

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

11/44

8-11

Suppose Ippo Ltd. purchased a land forRM150,000 by paying a quarter of the costof land in cash and the remaining purchase

price by signing a note payable. Othercash expenses to acquire the land includeRM5000 of realtor commission, RM3000

transfer fees, RM2500 survey fee, RM4500sprinkler system, RM10,000 for alarmsystem and RM45,000 for somelandscaping work.

Acquisition Cost Land - Example

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

12/44

Acquisition by Construction

8-12

Asset cost includes:

All materials andlabor traceable tothe construction.

A reasonableamount ofoverhead.

Interest on debtincurred during

the construction.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

13/44

Depreciation

8-13

Depreciation is a cost allocation processthat systematically and rationally matches

acquisition costs of operational assetswith periods benefited by their use.

Cost

Allocation

(Unused)

Balance Sheet

(Used)

Income Statement

ExpenseAcquisition

Cost

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

14/44

Depreciation

8-14

DepreciationExpense

Income

Statement

BalanceSheet

AccumulatedDepreciation

Depreciation for

the current year

Total of depreciationto date on an asset

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

15/44

Depreciation on Deltas2000 Balance Sheet

8-15

Book Values

Property and Equipment:

Flight equipment 17,565$

Less: Accumulated depreciation 5,173 12,392$

Ground property and equipment 4,371Less: Accumulated depreciation 2,313$ 2,058

Advance payments for equipment 390

Total property and equipment 14,840$

Book value = Market value/

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

16/44

Depreciation Concepts

The calculation of depreciation requiresthree amounts for each asset:

Acquisition cost.

Estimated useful life.

Estimated residual value.

8-16

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

17/44

Alternative DepreciationMethods

Straight-line

Units-of-production

Accelerated Method:Declining balance

8-17

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

18/44

Straight-Line Method

At the beginning of the year, Delta purchasedequipment for $62,500 cash. The equipment has

an estimated useful life of 3 years and anestimated residual value of $2,500.

8-18

Cost - Residual Value

Life in Years

Depreciation

Expense per Year=

SL

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

19/44

The formula for computing annual depreciation expense is:

Depreciable Cost / Useful Life (in years) = Depreciation Expense

8-19

ILLUSTRATION FORMULA FORSTRAIGHT-LINE METHOD

Cost

Salvage

Value

Depreciable

Cost

UsefulLife (in Years)

AnnualDepreciation

Expense

DepreciableCost

$62,500 - $2,500 = $60,000

$60,000 3 = $20,000

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

20/44

Straight-Line Method

8-20

Depreciation Accumulated Accumulated Undepreciated

Expense Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)

62,500$

1 20,000$ 20,000$ 20,000$ 42,5002 20,000 20,000 40,000 22,500

3 20,000 20,000 60,000 2,500

60,000$ 60,000$

Residual Value

SL

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

21/44

Units-of-Production Method

8-21

Depreciation

Rate

= Cost - Residual Value

Life in Units of Production

Step 1:

Step 2:

DepreciationExpense

=Depreciation

Rate

Number ofUnits Produced

for the Year

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

22/44

Units-of-Production Method

At the beginning of the year, Deltapurchased ground equipment for $62,500cash. The equipment has a 100,000 mile

useful life and an estimated residual valueof $2,500.

If the equipment is used 30,000 miles in thefirst year, what is the amount of depreciation

expense?

8-22

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

23/44

To use the units-of-activity method, 1) the total units of activity for the

entire useful life are estimated, 2) the amount is divided intodepreciable cost to determine the depreciation cost per unit, and 3) thedepreciation cost per unit is then applied to the units of activity duringthe year to determine the annual depreciation.

8-23

ILLUSTRATION 10-11FORMULA FOR UNITS-OF-ACTIVITY METHOD

DepreciableCost

Total Units ofActivity

DepreciableCost per Unit

$60,000 100,000 miles = $0.60

Units ofActivity during

the Year

AnnualDepreciation

Expense

DepreciableCost per Unit

$0.60 x 30,000 miles = $18,000

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

24/44

Accelerated Depreciation

Accelerated depreciation matches higherdepreciation expense with higher

revenuesin the early years of an assets useful life

when the asset is more efficient.

8-24

Depreciation Repair

Expense Expense

Early Years High Low

Later Years Low High

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

25/44

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

26/44

Double-Declining-BalanceMethod- Illustration 1

8-26

At the beginning of the year, Deltapurchased equipment for $62,500 cash.The equipment has an estimated usefullife of 3 years and an estimated residual

value of $2,500.

Calculate the depreciation expensefor the first two years.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

27/44

Unlike the other depreciation in illustration 1, salvage valueis ignored in determining the amount to which the decliningbalance rate is applied.

A common application of the declining-balance method is

the double-declining-balance method, in which the declining-balance rate is double the straight-line rate.

If DELTA uses the double-declining-balance methode, thedepreciation is 66.6% (2 X the straight-line rate of 33.3%).

8-27

ILLUSTRATION 2

Double-Declining-Balance Method

AnnualDepreciation

Expense

DepreciableCost

$62,500 x 66.6% = $41,625

double thestraight-linerate

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

28/44

MAINTANING THE ASSET

CAPITAL OF REVENUEEXPENDITURE?

CAPITAL EXPENDITURE

EXTEND THE USEFUL LIFE OF ASSET INCREASE ASSETS CAPACITY OR

PRODUCTIVITY

PROVIDE VALUE THAT EXTEND

BEYOND THE CURRENT PERIOD REVENUE EXPENDITURE

ORDINARY EXPENSES TREAT ASEXPENSES

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

29/44

Repairs, Maintenance,and Additions

8-29

Type of Capital or

Expenditure Revenue Identifying Characteristics

Ordinary Revenue 1. Maintains normal operating condition

repairs and 2. Does not increase productivity

maintenance 3. Does not extend life beyond original

estimate

Extraordinary Capital 1. Major overhauls or partial

repairs replacements

2. Extends life beyond original estimate

Additions Capital 1. Increases productivity

2. May extend useful life

3. Improvements or expansions

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

30/44

Capital and RevenueExpenditures

8-30

Many companies have policies expensing allexpenditures below a certain amount according to

the materiality constraint.

Financial Statement Effect

Current Current

Treatment Statement Expense Income Taxes

Capital Balance sheet

Expenditure account debited Deferred Higher Higher

Revenue Income statement Currently

Expenditure account debited recognized Lower Lower

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

31/44

Asset Impairment

Impairment is the loss of a significant portionof the utility of an asset through . . .

Casualty.

Obsolescence.Lack of demand for the assets services.

8-31

A loss should be recognized when anasset suffers a permanent impairment.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

32/44

Disposal of Property, Plant,and Equipment

Voluntary disposals:Sale

Trade-in

Retirement

Involuntary disposals:

Fire

Accident

8-32

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

33/44

Disposal of Property, Plant,and Equipment

8-33

Update depreciationto the date of disposal.

Journalize disposal by:

Writing off accumulateddepreciation (debit).

Writing off theasset cost (credit).

Recording cashreceived (debit)

or paid (credit).

Recording again (credit)

or loss (debit).

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

34/44

Disposal of Property, Plant,and Equipment

8-34

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

35/44

Disposal of Property, Plant,and Equipment

8-35

Delta Airlines sold flight equipmentfor $5,000,000 cash at the end of its

17th year of use. The flight equipmentoriginally cost $20,000,000, and wasdepreciated using the straight-line

method with zero salvage value

and a useful life of 20 years.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

36/44

8-36

The amount of depreciationrecorded at the end of the 17th year

to bring depreciation up to date is:

a. $0.

b. $1,000,000.c. $2,000,000.

d. $4,000,000.

Disposal of Property, Plant,and Equipment

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

37/44

8-37

After updating the depreciation,the equipments book value at the

end of the 17th year is:

a. $3,000,000.

b. $16,000,000.c. $17,000,000.

d. $4,000,000.

Disposal of Property, Plant,and Equipment

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

38/44

8-38

The equipments sale resulted in:

a. a gain of $2,000,000.

b. a gain of $3,000,000.

c. a gain of $4,000,000.

d. a loss of $2,000,000.

Disposal of Property, Plant,and Equipment

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

39/44

Disposal of Property, Plant,and Equipment

8-39

GENERAL JOURNAL Page 8

Date Description Debit Credit

Prepare the journal entry to record Deltas saleof the equipment at the end of the 17th year.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

40/44

Natural Resources

8-40

Examples: oil, coal, gold

Extracted fromthe natural

environment.

A noncurrentasset presented

at cost less

accumulateddepletion.

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

41/44

Natural Resources

8-41

Depletion is like depreciation.

Total cost ofasset is the costof acquisition,

exploration,and development.

Total cost isallocated over

periods benefited

by means ofdepletion.

D l i f N l

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

42/44

Depletion of NaturalResources

8-42

Depletion is calculated using the

units-of-production method.

Unit depletion rateis calculated as follows:

Estimated Recoverable Units

Acquisition and Residual

Development Cost Value

D l i f N l

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

43/44

Depletion of NaturalResources

Total depletion cost for a period is:

8-43

UNIT DEPLETION

RATE

NUMBER OF UNITS

EXTRACTED IN PERIOD

Totaldepletioncost

Inventoryfor sale

UnsoldInventory

Cost ofgoods sold

8/2/2019 20110208130220TANGIBLE ASSETS 2003 (1)

44/44

Specialized plant assets may be required toextract the natural resource.

These assets are recorded in a separateaccount and depreciated.

Natural Resources