Financial accounting 9th jamie pratt chapter 09

Chapter 9:
Long-Lived Assets


Long – Lived Assets
 Land
 Has indefinite life and therefore is not depreciated
 Historical Cost includes:


Purchase price, Closing costs, Cost to get ready
for intended use (Note: Sale of salvaged materials
reduces cost)

 Land Improvements
 Have definite life and therefore are depreciated
 Fences, walls, parking lots, driveways


Long – Lived Assets
 Buildings


Have definite life and therefore are depreciated



Proportionate share of purchase price, or construction cost, Closing Cost,
Architect & Attorney fees

 Machinery, Equipment, Furniture & Fixtures


Purchase price (net of cash discounts), Freight & handling, Insurance
while in transit, Installation

 Intangible assets


Rights, privileges, and benefits of possession



No physical existence



Includes cost and the cost to defend them



Amortized over useful life (if indefinite life, no amortization)


The Relative Size of Long-Lived Assets

Figure 9-1
Property, plant,
and equipment
plus

Intangible as a
percentage of
total assets


Capitalize vs. Expense


Revenue Expenditures



Merely maintain a given level of services
Should be Expensed

Debit Expense


Capital Expenditures


Provide future benefits (useful life > 1 year)



Matching principle
Should be Capitalized



Debit Asset


Financial Statement Effects

Figure 9-2 (Partial) The effects of depreciation period on the financial statements: Rudman
Manufacturing


Overview of Accounting for Property, Plant,
and Equipment

Figure 9-4 Accounting for long-lived assets


Acquisition: What Costs to Capitalize?
 General Rule:
 Capitalize (add to an asset account) the costs to

acquire the asset and bring it to its serviceable
or usable condition and location.


Dr. Asset (purchase price, sales tax,
delivery, installation, etc)



Cr. Cash, Notes Payable, etc

Construction of Long - Lived Assets
What to Capitalize?
•
•
•
•

Direct Materials
Labor
Overhead
Interest During Construction


Postacquisition Expenditures: Betterments
or Maintenance?
•

•

Maintain current level of productivity
• Repairs and maintenance
• Expensed as incurred
Betterments – one of the following must apply
• Increase useful life beyond the initial estimate
• Improve quality of output
• Increase quantity of output
• Reduce costs of operating the asset

Cost Allocation: Amortizing Capitalized Costs
 The costs are to be matched against the benefits

produced by the asset
 Estimate the Useful Life – based on physical

obsolescence
 Estimate a Salvage Value – based on amount that

can be recovered on the asset
 Choose a cost allocation (depreciation) method.


Cost Allocation: Amortizing Capitalized Costs
•

Technical Obsolescence is another challenge that
must be overcome in estimating useful life and
salvage value.

•

Changes in estimates related to depreciation are
treated prospectively – determine current book
value and recalculate depreciation going forward.
Remaining Book Value - New Est. Salvage
Remaining Estimated Life


Cost Allocation (Depreciation) Methods

There are a variety of depreciation methods utilized. The more common
methods are covered in this text.





The Straight-Line Method of Amortization (Depreciation)
 (Cost – Salvage Value)/Useful Life



Double Declining Balance Method
 (2XBook Value)/Useful Life



The Activity (Units-of-Production) Method
Cost - Salvage Value
x Current Activity
Total expected activity



Natural Resource Depletion
Cost - Salvage Value
x Current Activity
Total expected activity

Class Example
Given the following information regarding an automobile
purchased by the company on January 2, 2014:
Cost to acquire = $10,000
Estimated life = 4 years
Estimated miles = 100,000 miles
Salvage value = $2,000
Calculate depreciation expense for the first two years under
each of the following methods.


Units-of-Production (Activity)
Assume that the car was driven 20,000 miles in the year
2013, and 30,000 miles in 2014.
Annual depreciation =
Cost - Salvage Value

x Current Activity

Total expected activity
For 2013= 10,000 - 2,000 x 20,000 = $1,600
100,000 miles
For 2014 = 10,000 - 2,000 x 30,000 = $2,400
100,000 miles


Straight-Line
Annual depreciation =

=

Cost - Salvage
Estimated Life

$10,000 - $2,000 = $2,000 per year
4 years


Double-Declining Balance
DDB is an accelerated depreciation technique. It
generates more expense in the early years and less
in the later years.
Annual depreciation = (2 X Book Value)/ Useful Life

Depreciation expense (D.E.)for:
2013 = (2 x 10,000)/4 = $5,000
2014 = {2 x(10,000-5,000)}/4 = $2,500


How does Management Choose and
Acceptable Cost Allocation Method
 Effect on the Financial Statements
 Effect on Income Taxes
 Management may use a different

depreciation method for financial
statements and income taxes
 IRS tax rules effect allowable

depreciation methodologies

Class Problem: Problem 9-7
(a) Book Value at 1/1/14:
First: annual depr. expense =
(180,000-30,000)/10 = 15,000/yr.
Then Accumulated Depr. to 1/1/14:
15,000 x 5 yrs = $75,000
So BV = 180,000 - 75,000 = 105,000


Class Problem: Problem 9-7
(b) Estimate for 2014, assuming revised useful life:

BV - SV = 105,000 - 30,000 = $9,375 per yr.
Remaining life
(10 – 5) +3
Journal entry:
Depreciation Expense
Accum. Depreciation

9,375
9,375


Disposal: Retirement, Sale and Trade-Ins
 Retirement :

Dr. Loss (if not fully depreciated)
Dr. Acc Dep

Cr. Asset
 Sale:

Dr. Cash
Dr. Acc Dep
Cr. Asset
 Dr. Loss if BV > Cash or Cr. Gain if BV < Cash

 Trade-ins (for dissimilar assets): asset received should be valued at
 The fair market value of assets given up, or
 The fair market value of the asset received,


Whichever is more evident and objectively determined


Disposals (cont’d)
Using earlier example (cost = $10,000, salvage = $2,000).
After 4 years straight-line, $8,000 would be in A/D.

1. Assume the asset is retired (no cash received)
Loss on retirement 2,000
Accumulated Depr. 8,000
Automobiles 10,000
2. Assume the asset is sold for $3,000:
Cash 3,000
Accumulated Depr. 8,000
Automobiles 10,000

Class Exercise: Exercise 9-15
First calculate depreciation:
DDB % = (2xBV)/Useful Life
Depr. Book
Date
Calculation
Expense

Value

1/1/12 25,000
12/31/12

(2x25,000)/5

= 10,000 15,000

12/31/13

(2x15,000)/5

= 6,000 9,000

12/31/14

(2x9,000) / 5

= 3,600

12/31/15

400*

12/31/16

-0- 5,000

5,400

5,000=SV

*formula will exceed salvage value limit in 2015; just depreciate
$400, to salvage of $5,000.


Exercise 9-15 (cont’d)
(a) JE to scrap after 3 years, at 12/31/14, assumes that no cash
is received:
Dr. Loss on Disposal
5,400
Dr. Acc Dep
19,600
Cr. Equipment
25,000

(b) JE to scrap after 5 years, assumes that no cash is received:
Dr. Loss on Disposal
5,000
Dr. Acc Dep
20,000

Cr. Equipment
25,000