Financial Accounting - Chapter 8

Chapter 8
Operating Assets: Property, Plant,

and Equipment, and Intangibles
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Learning Objectives
LO1 Understand balance sheet disclosures for operating assets.
LO2 Determine the acquisition cost of an operating asset.
LO3 Explain how to calculate the acquisition cost of assets
purchased for a lump sum.
LO4 Describe the impact of capitalizing interest as part of the
acquisition cost of an asset.
LO5 Compare depreciation methods and understand the factors
affecting the choice of method.
LO6 Understand the impact of a change in the estimate of the
asset life or residual value.
Learning Objectives (continued)
LO7 Determine which expenditures should be capitalized as
asset costs and which should be treated as expenses.
LO8 Analyze the effect of the disposal of an asset at a gain or
loss.
LO9 Understand the balance sheet presentation of intangible
assets.
LO10 Understand the proper amortization of intangible assets.
LO11 Explain the impact that long-term assets have on the
statement of cash flows.
LO12 Understand how investors can analyze a companys
operating assets.
Module 1 Acquisition of Operating
Assets
Operating assets appear on the balance sheet
and companies account for the acquisition of
assets
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1
Operating Assets
Presented in two categories on the balance
sheet:
Property, Plant and Equipment
Intangible Assets
Essential to a companys long-term future

Used to produce the goods or services the company
sells to customers
Presented at their acquisition cost
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 1
Balance Sheet Presentation of
Property, Plant, and Equipment
Balance sheet uses one line item for property,
plant, and equipment and presents the details
in the notes
Acquisition of Property, Plant, and
Equipment
Initially recorded at acquisition cost or original
cost
Includes all cost normally necessary to acquire
an asset and prepare it for its intended use
Purchase price
Taxes paid at time of purchase (for example, sales
tax)
Transportation charges
Installation costs
Group Purchase
Firm purchases several assets as a group and
pays a lump-sum amount
Acquisition cost of each asset is separately
measured on the basis of the proportion of the
fair market value of each
Example 8-1Determining Cost
When a Group of Assets Is
Purchased
Assume that on January 1, ExerCo purchased a building and the land on
which it is situated for $100,000
The accountant established the assets fair market value on January 1 as
follows:
Land $30,000
Building 90,000
Total 120,000
Based on the estimated market values, the purchase price should be
allocated as follows:
To land $100,000 $30,000/$120,000 = $25,000
To building $100,000 $90,000/$120,000 = $75,000
Example 8-1Determining Cost
When a Group of Assets Is
Purchased (continued)
The journal entry to record the purchase in Example 8-1 would be as follows:
Capitalization of Interest
The interest on borrowed money should be
treated as an expense of the period
If a company constructs an asset over a period
of time and borrows money to finance the
construction
The interest incurred during the construction period
is not treated as interest expense
The interest must be included as part of the
acquisition cost of the asset
Land Improvements
The acquisition cost of land should be kept in a
separate account because land has an unlimited
life and is not subject to depreciation
Costs associated with land should be recorded
in an account such as Land Improvements
Example: costs of paving a parking lot and
landscaping costs
Have a limited life
Should be depreciated over their useful lives
Module 2 Depreciation and
Disposal of Operating Assets
A company records depreciation of operating
assets and certain factors affect the choice of
depreciation method
A company accounts for repairs of the asset and
there is an effect of disposal of an asset at a gain
or loss
Use and Depreciation of Property,
Plant, and Equipment
Depreciation: the allocationof the original cost
of an asset to the periods benefited by its use
Methods of depreciation:
Straight-line
Units-of-production
Accelerated depreciation
The method chosen should be one that best
matches the expense to the revenue generated
by the asset
Straight-Line Method
Allocates the cost of the asset evenly over time
Depreciation = Acquisition Cost Residual Value
Life
Example 8-2Computing
Depreciation Using the Straight Line
Method
Assume that on January 1, 2016, ExerCo, a manufacturer of exercise
equipment, purchased a machine for $20,000
The machines estimated life would be five years, and its residual value at the
end of 2020 would be $2,000
The annual depreciation should be calculated as follows:

Life
= ($20,000-$2,000)/5
= $3,600
Method (continued)
An assets book value is defined as its acquisition cost minus its total amount
of accumulated depreciation
The book value of the machine in this example is $16,400 at the end of 2016:
Book Value = Acquisition Cost Accumulated Depreciation
= $20,000-$3,600
= $16,400
Method (continued)
An assets book value is defined as its acquisition cost minus its total amount
of accumulated depreciation
The book value of the machine in this example is $16,400 at the end of 2016:
Book Value = Acquisition Cost Accumulated Depreciation
= $20,000- (2x $3,600)

= $12,800
Units-of-Production Method
Depreciation is determined as a function of the
number of units the asset produces
Total Number of Units in Assets Life
The annual depreciation for a given year can be

calculated based on the number of units
produced during that year, as follows:
Annual Depreciation = Depreciation per Unit x Units Produced in Current
Year
Depreciation Using the Units-of-
Production Method
ExerCo has estimated that the total number of units that will be produced
during the assets five-year life is 18,000
During 2016, ExerCo produced 4,000 units
The depreciation per unit for ExerCos machine can be calculated as follows:
Total Number of Units in Assets Life
= ($20,000 - $2,000)/18,000
= $1 per unit
Depreciation Using the Units-of-
Production Method (continued)
The amount of depreciation that should be recorded as an expense for 2016
is $4,000
Annual Depreciation = Depreciation per Unit x Units Produced in Current
Year
= $1 per Unit x 4,000 Units
= $4,000
Accelerated Depreciation Method
Higher amount of depreciation is recorded in
the early years than in later years
Double-declining-balance method: recorded at
twice the straight-line rate, but the balance is
reduced each period
Depreciation Using the Double-
Declining-Balance Method
Assume that ExerCo wants to depreciate its asset using the double-declining-
balance method
The straight-line rate for the ExerCo asset with a five-year life is as follows:
100% / 5 Years = 20%
The second step is to double the straight-line rate, as follows:
2 x 20% = 40%
Example 8-4Computing Depreciation
Using the Double-Declining-Balance
Method (continued)
This rate will be applied in all years to the assets book value at the beginning
of each year
As depreciation is recorded, the book value declines and a constant rate is
applied to a declining amount
However, the machine cannot be depreciated below its residual value
The amount of depreciation for 2016 would be calculated as follows:
Depreciation = Beginning Book Value x Rate
= $20,000 x 40%
= $8,000
Example 8-4Computing Depreciation
Using the Double-Declining-Balance
Method (continued)
The amount of depreciation for 2017 would be calculated as follows:
Depreciation = Beginning Book Value x Rate
= ($20,000 - $8,000) x 40%

= $4,800
Exhibit 8-1Comparision of
Depreciation and Book Values of
Straight-Line and Double-Declining
Balance Methods
Exhibit 8-2Managements Choice
of Depreciation Method
Change in Depreciation Estimate
Change in the life of the asset or in its residual
value
Recorded prospectively
The depreciation recorded in prior years is not
corrected or restated
The new estimate should affect the current year and
future years
Example 8-5Calculating a Change
in Depreciation Estimate
ExerCo purchased a machine on January 1, 2016, for $20,000 and estimates
that the machines life would be five years and its residual value at the end of
five years would be $2,000
At the beginning of 2018, ExerCo believes that the total machine life will be
seven years, or another five years beyond the two years the machine has
been used
The amount to be depreciated over that time period should be calculated as
follows:
Example 8-5Calculating a Change in
Depreciation Estimate (continued)
The remaining depreciable amount should be recorded as depreciation over
the remaining life of the machine
The depreciation amount for 2018 and the following four years would be
$2,160:
Depreciation = Remaining Depreciable Amount/Remaining Life
= $10,800/5 Years
= $2,160
Example 8-5Calculating a Change in
Depreciation Estimate (continued)
The journal entry to record depreciation for the year 2018 is as follows:
Capital versus Revenue
Expenditures
Capital expenditure: a cost that improves the
asset and is added to the asset account (item
treated as asset)
Revenue expenditure: a cost that keeps an
asset in its normal operating condition and is
treated as an expense (item treated as an
expense of the period)
Capital versus Revenue
Expenditures
Example 8-6Capitalizing Costs
of a Major Repair
At the beginning of 2018, ExerCo made a $3,000 overhaul to the machine,
extending its life by three years
The amount to be depreciated over that time period should be calculated as
follows:
of a Major Repair (continued)
Beginning in 2018, the company should record depreciation of $2,300 per
year, computed as follows:
Depreciation = Remaining Depreciable Amount/Remaining Life
= $13,800/6 Years
= $2,300
The journal entry to record the overhaul in Example 8-6 is as follows:
The entry to record depreciation for the year 2018 is as follows:
Disposal of Property, Plant, and
Equipment
Occurs when the asset is sold, traded, or
discarded
Update depreciation to the date of disposal and
calculate gain or loss
A gain occurs when the selling price of the asset
exceeds its book value
A loss occurs when the selling price of the asset is
less than its book value
Gain or loss is reported in the Other Income or
Expense category of the income statement
Example 8-7Calculating the Gain
on Sale of an Asset
Assume that ExerCo purchased a machine on January 1, 2016, for $20,000,
estimating its life to be five years and the residual value to be $2,000
ExerCo sold the machine on July 1, 2018
Depreciation for the six-month period from January 1 to July 1, 2018, is
$1,800 ($3,600 per year 1/2 year $1,800) and should be recorded as
follows:
Example 8-7Calculating the Gain
on Sale of an Asset (continued)
After the July 1 entry, the balance of the Accumulated Depreciation
Machine account is $9,000, which reflects depreciation for the 2 years from
the date of purchase to the date of sale
The entry to record the sale is as follows:
Loss on Sale of Assets
The calculation of a loss on the sale of an asset is similar to that of a gain
Depreciation must be recorded to the date of sale, July1
Following is the entry to record the sale of the asset:
Example 8-8Calculating the Loss
on Sale of an Asset
Assume that ExerCo sold the asset on July 1, 2018, for $10,000. The loss
could be calculated as follows:
IFRS and Property, Plant, and
Equipment
IFRS requires estimates of residual value and the
life of the asset be reviewed at least annually
FASB standards does not require the annual review
The international standards also indicate that
companies should determine the components of an
asset and depreciate each component separately
International Standards allow companies to revalue
the assets to reflect their fair market values
FASB does not allow the revaluing to fair market value
Module 3 Intangible Assets
Intangible assets on the balance sheet are
important
Intangible Assets
Assets with no physical properties
Recorded as assets, because they provide future
economic benefits to the company
Long-term assets and should be shown
separately from property, plant, and equipment
Exhibit 8-3Most Common
Intangible Assets
Acquisition Cost of Intangible
Assets
Includes costs to acquire and prepare it for its
intended use
Includes:
Purchase Price
Acquisition costs
Costs that are incurred after acquisition and that are
necessary to the existence of the asset
Exhibit 8-4The Nike, Inc.,
Consolidated Assets Section and
Intangibles Notes
Research and Development Costs
Costs incurred in the discovery of new
knowledge
According to FASB, all such expenditures must
be treated as expenses in the period incurred
Patent account should not include the costs of
research and development of a new product
Amortization of Intangibles
Intangibles with finite life must be amortized
Recorded over the legal life or the useful life,
whichever is shorter
Mostly recorded using the straight-line method
Intangibles with indefinite life are not

amortized
Example: trademark, goodwill, and broadcast
license
Example 8-9Calculating the
Assume that Nike developed a patent for a new shoe product on January 1,
2016
Costs involved with patent approval were $10,000, and the company wants to
record amortization on the straight-line basis over a five-year life with no
residual value
Nike should record amortization over the useful life as $10,000/5 years
$2,000
(continued)
The accounting entry to record the amortization for 2016 is as follows:
(continued)
Rather than use an accumulated amortization account, some companies
decrease (credit) the intangible asset account directly
In that case, the preceding transaction is recorded as follows:
Goodwill and Impairments
As per the FASB, goodwill should be treated as
an intangible asset with an indefinite life and
that companies should not record amortization
expense related to goodwill
Each year, assets with indefinite life should be
checked for impairment
If an impairment has occurred, a loss should be
recognized
Goodwill and Impairments
Assume that Nike learns on January 1, 2017, when accumulated amortization
is $2,000 (or the book value of the patent is $8,000), that a competing
company has developed a new product that renders Nikes patent worthless
Nike has a loss of $8,000 and should record an entry to write off the asset as
follows:
IFRS and Intangible Assets
International standards are more flexible than
the FASB standards in allowing the use of fair
market values for intangible assets
Active market must exist
Fair value must be possible to determine
Research and development costs

FASB: all such costs should be treated as an expense
IFRS: Research costs be treated as an expense and
development costs can be capitalized as an asset
Module 4 Cash Flow and Analysis
Issues
Operating assets can impact the cash flows of
the company and investors analyze a companys
operating assets
Exhibit 8-5Long-Term Assets and
the Statement of Cash Flows
Analyzing Long-Term Assets for
Average Life
What is the average depreciable period (or life)
of the companys assets?
Average Life = Property, Plant, and Equipment
Depreciation Expense
Average Age
Are assets old or new?
Average Age = Accumulated Depreciation
Depreciation Expense
Asset Turnover
How productive are the companys assets?
Asset Turnover = Net Sales
Average Total Assets
Review
LO1 Understand balance sheet disclosures for operating assets.
Operating assets are the major productive assets of many companies,
and investors must be able to evaluate the long-term potential of
these assets for a return on their investments.
Operating assets may be classified as either tangible or intangible
assets.
Tangible assets are referred to as property, plant, and equipment (or
fixed assets).
Intangible assets include goodwill, patents, copyrights, and various
types of intellectual property.
Review
LO2 Determine the acquisition cost of an operating asset.
Assets classified as property, plant, and equipment (or fixed assets)
are initially recorded at the cost to acquire the assets, also referred to
as historical cost or original cost.
Acquisition costs include those costs that are normal and necessary
to acquire the asset and prepare it for its intended use. Generally,
acquisition costs include purchase price, taxes paid at time of
purchase, transportation charges, and installation costs.
Review
LO3 Explain how to calculate the acquisition cost of assets
purchased for a lump sum.
If more than one asset is purchased for a single sum of money, the
acquisition costs must be allocated between the assets.
In these cases, the purchase price should be allocated between the
assets acquired based on the proportion of the fair market value each
asset represents of the total purchase price.
LO4 Describe the impact of capitalizing interest as part of the
acquisition cost of an asset.
Generally, the interest on borrowed money used to acquire assets
should not be capitalized; instead, it should be treated as an expense
of the period.
Review
LO5 Compare depreciation methods and understand the factors
affecting the choice of method.
Several depreciation methods are available, including straight-line,
units-of-production, and accelerated depreciation methods.
In theory, the depreciation method that best allocates the original
cost of the asset to the periods benefited by the use of the asset
should be chosen.
LO6 Understand the impact of a change in the estimate of the
asset life or residual value.
Occasionally, an estimate of the assets life or residual value must be
modified after the depreciation process has begun. This is an example
of an accounting change that is referred to as a change in estimate.
Review
LO7 Determine which expenditures should be capitalized as
asset costs and which should be treated as expenses.
Capital expenditures are added to the acquisition cost of an asset and
are depreciated over time.
Revenue expenditures are not treated as part of the cost of the asset,
but as an expense on the income statement in the period incurred.
LO8 Analyze the effect of the disposal of an asset at a gain or
loss.
The gain or loss on an asset is the difference between the sales (or
exchange) price and the book value of the asset, where book value is
the acquisition cost less any accumulated depreciation on the asset.
Review
LO9 Understand the balance sheet presentation of intangible
assets.
Intangible assets are long-term assets that should be shown
separately from property, plant, and equipment on the balance sheet.
LO10 Understand the proper amortization of intangible assets.
The amortization of intangibles is a process similar to that of
depreciating capital assets.
If an intangible asset has a finite useful life, amortization expense
must be taken on the asset over the legal life or useful life, whichever
is shorter.
Review
LO11 Explain the impact that long-term assets have on the
Long-term assets impact the statement of cash flows when they are
acquired, depreciated, and sold.
Cash used to acquire long-term assets or cash received on the sale of
long-term assets is reflected in the Investing Activities section of the
Depreciation and amortization are noncash expenses recorded on the
accrual income statement.
Accordingly, net income on a cash basis must be arrived at by adding
depreciation and amortization back to accrual net income.
Review
LO12 Understand how investors can analyze a companys
operating assets.
Investors are interested in how productive a companys operating
assets are.
The Ratios are a valuable tool that can be used to examine the
productivity of operating assets with the asset turnover ratio.
End of Chapter 8

Financial Accounting - Chapter 8

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Accounting - Chapter 8

Uploaded by

Copyright:

Available Formats

Chapter 8

Operating Assets: Property, Plant,

Essential to a companys long-term future

Depreciation = Acquisition Cost Residual Value

Book Value = Acquisition Cost Accumulated Depreciation

Book Value = Acquisition Cost Accumulated Depreciation

= $20,000- (2x $3,600)

The annual depreciation for a given year can be

100% / 5 Years = 20%

The second step is to double the straight-line rate, as follows:

Depreciation = Beginning Book Value x Rate

Depreciation = Beginning Book Value x Rate

= ($20,000 - $8,000) x 40%

Depreciation = Remaining Depreciable Amount/Remaining Life

Intangibles with indefinite life are not

Research and development costs

You might also like