Chapter 7 Long-Term Assets

Long-Term Assets

Long-Term Assets :
Land Land improvements Building Equipment Natural resources

Cost of LongTerm Assets

Cost includes the acquisition cost plus any one-time expenditures like transportation, installations, etc. incurred to bring the asset to its usable condition. We say that we are capitalizing these costs. These costs are debited to the asset account.

Land Improvements
Any additional amount spent to improve the land by constructing a parking lot, paving, temporary landscaping, lighting systems, fences, sprinkler systems etc. are recorded as land improvements. Are subject to depreciation. Note: We depreciate land improvements but not land.
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Expenditures after Acquisition

1. Repairs and Maintenance 2. Additions and Improvements

Expenditures after Acquisition

Large (non-recurring) expenditures that the increase the utility/productivity of long-term assets are added to the cost of the asset (debited to the asset account). e.g., an engine overhaul. Small recurring expenses that maintain productivity) like engine tune-up, etc. are expensed when incurred (debited to the expense account).
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Depreciation of Tangible Assets

Dictionary definition = Decrease in value from usage. Accounting definition = Allocation of an assets cost.

Allocating the cost of an asset over its useful life. Three methods used: Straight-line Declining balance Activity based.
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Straight-Line Depreciation
Allocates an equal amount of the depreciable base to each year of the assets service life

Straight-Line Depreciation

= Assets service (useful ) life

Asset cost - Estimated residual value

Declining-Balance Depreciation
An accelerated depreciation method Will be higher than straight-line depreciation in earlier years, but lower in later years Both declining-balance and straight-line will result in the same total depreciation over the assets service life The most common declining-balance rate is 200%, which we refer to as the doubledeclining-balance method since the rate is double the straight-line rate
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Activity-Based Depreciation
Yearly depreciation is based on units consumed over its useful life, e.g., total expected miles a car would run. Step 1 Compute the average depreciation rate per unit Asset cost - residual value Units expected to be produced

Step 2
Multiply the average depreciation rate per unit by the number of units each period
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Example
Speedy Delivery Company purchases a delivery van for $29,000. Speedy estimates that at the end of its fouryear service life, the van will be worth $3,625. During the four-year period, the company expects to drive the van 119,000 miles. Actual miles driven each year were 34,200 miles in year 1; 37,100 miles in year 2; 29,600 miles in year 3; and 30,100 miles in year 4. Note that actual total miles of 131,000 exceed expectations by 12,000 miles. Required: Calculate annual depreciation for the four-year life of the van using each of the following methods.
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Disposal of Long-Term Assets

Disposal of Long-Term Assets

Sale

Retirement

Exchange

Can result in either a gain or a loss

Occurs when a longterm asset is no longer useful but cannot be sold for a price

Occurs when two companies trade assets

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Recording Long-Term Asset Disposals

Little King Sandwiches purchased a new delivery truck. Here are the specific details:
Cost of the new truck Estimated residual value Estimated service life $40,000 $5,000 5 years

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Example of Disposal
If we assume that Little King sells the delivery truck at the end of year 3 for $22,000, we can calculate the gain as $3,000. Note that both the delivery truck and the related accumulated depreciation account are removed from the books.
Sale amount Less: Cost of the new truck $40,000 $22,000

Less: Accumulated depreciation (3 years x $7,000/year)

Book value at the end of year 3 Gain on sale The entry to record the gain on sale is: Cash Accumulated Depreciation Delivery Truck Gain on sale (To record gain on sale) 22,000 21,000

(21,000)
19,000 $3,000

40,000 3,000
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Retirement
If we assume that the delivery truck is totaled in an accident at the end of year 3, we have a $19,000 loss on retirement.
Sale amount Less: Cost of the new truck Less: Accumulated depreciation (3 years x $7,000/year) Book value at the end of year 3 Loss on retirement The entry to record the loss on retirement is: Accumulated Depreciation Loss on Retirement Delivery Truck (To record loss on retirement)
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$0

$40,000 (21,000) 19,000 ($19,000)

21,000 19,000 40,000

Intangible Assets
Assets that give the right to manufacture a product or reproduce a piece of art, e.g., patents, copyrights, franchises, trademarks, etc.

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Goodwill
Refers to the excess of market value over the book value of its net assets. May result from any unique attributes like trained employees, reputation, unique location, etc. Recorded as an intangible asset in the balance sheet only when paid during the acquisition of another company.
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Amortization of Intangible Assets

Allocation of the cost of an asset over its useful or legal life, whichever is shorter. Patents, Copyrights, Franchises have a definite life and are amortized. Goodwill and trademarks have an indefinite life and are not amortized. Usually straight-line method used to determine the amount of amortization.
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Natural Resources
Oil, Natural Gas, and Timber, etc.

Are consumed or depleted (but not depreciated). For example, Exxon Mobils oil reserves are a natural resource that decreases (depletes) as the firm extracts oil.
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Asset Analysis
Analyze the relation between Return on Assets, Profit Margin and Asset Turnover to analyze the profitability of a companys assets.

Return on Assets Net Income Average Total Assets

= =

Profit Margin Net Income Net Sales

x x

Asset Turnover Net Sales Average Total Assets

To maximize profitability, a company ideally strives to increase both net income per dollar of sales (profit margin) and sales per dollar of assets invested (asset turnover).

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Wal-Mart vs. Abercrombie

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