Chapter 8 Reporting and Interpreting Property Plant and Equipment Intangibles and Natural Resources Classifying Long Lived Assets Tangible Physical Substance Intangible No physical substance rights Land Assets subject to depreciation o Buildings and equipment o Furniture and fixtures Natural resource assets subject to depletion o Mineral deposits and timber Definite life o Patents o Copyrights o Franchises Indefinite life o Trademarks o Goodwill Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees Measuring and Recording Acquisition Cost All costs required to make the asset ready for use Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use does not include financing charges and cash discounts Repairs Maintenance and improvements Type of Expenditure Identifying Characteristics Ordinary 1 Maintains normal operating condition repairs and 2 Does not increase productivity maintenance 3 Does not extend life beyond original estimate 4 Recurring in nature and involve small amounts of money at each occurence Additions and 1 Major overhauls or partial Improvements replacements 2 Usually occur infrequently 3 Increases efficiency 4 May extend useful life 5 Involve large amounts of money Accounting Treatment Expense in period incurred Add to asset account Capitalize Financial Statement Effect Current Current Income Taxes Treatment Statement Expense Capitalize Balance sheet account debited Deferred Higher Higher Expense Income statement Currently account debited recognized Lower Lower To aid with the capitalize expense decision many companies record all expenditures below a certain dollar amount as expenses Depreciation process of allocating the cost of buildings and equipment over their productive lives using a systematic and rational method The calculation of depreciation requires three amounts for each asset 1 2 3 Acquisition cost Estimated useful life Estimated residual value Alternative depreciation methods 1 Straight line most common Depreciation Cost Residual Value Expense per year At the beginning of the year Southwest purchased ground equipment for 62 500 cash The equipment has an estimated useful life of 3 years and an estimated residual value of 2 500 62 500 2 500 20 000 3 years Useful Life 1 Depreciation Accumulated Depreciation credit Expense debit Accumulated Undepreciated Depreciation Balance Year 1 2 3 20 000 20 000 20 000 60 000 20 000 20 000 20 000 60 000 20 000 40 000 60 000 Balance book value 62 500 42 500 22 500 2 500 2 Units of production Annual depreciation expense Cost Residual value Production used Total production life Depreciation rate Net book value residual value Total lifespan 62 500 2 500 60 per mile 100 000 miles Depreciation Expense 60 per mile 30 000 miles 18 000 Year Miles Depreciation Expense 1 2 3 30 000 50 000 20 000 100 000 18 000 30 000 12 000 60 000 Accumulated Depreciation Balance 18 000 48 000 60 000 Undepreciated Balance book value 62 500 44 500 14 500 2 500 3 Accelerated Method Declining balance taxes Annual depreciation expense Net book value 2 at beginning of period Useful Life Net Book Value Cost Accumulated depreciation Depreciation Expense debit Accumulated Depreciation Balance Year 1 2 3 1 2 3 41 667 13 889 4 629 60 185 41 667 55 556 60 185 Depreciation Expense debit Accumulated Depreciation Balance Year 41 667 13 889 4 444 60 000 41 667 55 556 60 000 Undepreciated Balance book value 62 500 20 833 6 944 2 315 Undepreciated Balance book value 62 500 20 833 6 944 2 500 2 Asset type Tangibles Plant equipment Intangibles patents Natural resources gold mine Allocation of its use in business Depreciation Amortization Depletion Acquisition and Amortization of Intangible Assets Intangible Assets Noncurrent assets without physical substance that often provide exclusive rights or privileges Useful life is difficult to determine usually acquired for operational use Only purchased intangibles are recorded and they are normally recorded at current cash equivalent cost including purchase price legal fees and filing fees Amortization cost allocation process similar to depreciation and depletion Definite Life Amortize over shorter of economic life or legal life Use straight line method Indefinite Life Goodwill Not amortized Tested at least annually for possible impairment and book value is reduced to fair value if impaired Amortization is a cost allocation process similar to depreciation and depletion Goodwill occurs when one company buys another company Goodwill is not amortized Its value must be reviewed at least annually for possible impairment and the book value is only purchased goodwill is an intangible asset The amount by which the purchase price exceeds the fair market value of net assets acquired reduced to fair value if impaired Fair market value asset Fair market value liability Fair market value net assets Gain loss on Fair market value Goodwill Fixed Asset Net Sales or Operating Revenues Turnover Average Net Fixed Assets This ratio measures the sales dollars generated by each dollar of fixed assets used Research and development Expense not intangible assets under U S GAAP The cost to development an intangible asset internally is normally recorded as research and development expense Depletion similar to units of production depreciation Acquisition and Depletion of Natural Resources oil coal gold Extracted from the natural environment A noncurrent asset presented at cost less accumulated depletion Total cost is allocated over periods benefited by means of depletion Total cost of asset is the cost of acquisition exploration and development Unit depletion rate Acquisition and development cost residual value Estimate recoverable units Depreciation cost unit depletion rate of units extracted in period 3
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