Accounting 5.doc

Chapter 8 LONG-TERM ASSETS Long ? lived assets (also called Fixed assets) Major assets acquired for use in the continuing operations of a business (operating assets) Help produce revenues over many periods Includes: (1) Property, Plant, and Equipment ? includes land, buildings, equipment, furniture-PPE (2) Natural Resources ? includes oil deposits, coal deposits, timber (3) Intangible Assets ? includes copyrights, patents, trademarks, trade names, franchises, goodwill Accounting for Long-term assets includes three issues: 1. acquisition 2. use over its productive life 3. disposal PROPERTY, PLANT, AND EQUIPMENT Acquisition Cost principle: acquisition cost includes all normal and reasonable costs necessary to acquire asset and prepare it for intended use Land: includes costs such as real estate commissions, survey fees, attorney and legal fees, costs to prepare land for use (such as tearing down old structures less any salvage recovered) Land is NOT depreciated Land improvements: such as paving, fencing, outdoor lighting, etc, can be depreciated Buildings: if company constructs building, include construction costs and interest paid to finance during construction in cost of asset Equipment: includes taxes, transportation costs, installation costs (including testing) Example: Asset purchase On August 20, Montana Manufacturing Company purchased a new drill press. The new equipment had an invoice price of $15,000. The seller offered a cash discount of $300. Other costs associated with the purchase of the press included sales tax of $375, freight charges of $1,000, and installation and connection costs of $500. Montana also paid $240 in insurance for the first six months of the equipment?s use. Insurance while its being shipped is part of cost, but after the equipment is being used it is not part of the cost of the asset Determine the amount to be reported as the cost of the equipment. 15000-(300)+375+1000+500= cost Example: Group purchase Montana Manufacturing purchased a building, its surrounding land, and some equipment in a lump-sum purchase for $230,000. An appraisal showed the following values for each item: Building $180,000 Land 126,000 Equipment 54,000 Total 360,000 if purchased separately How should Montana record the acquisition of these assets? Now go through and find the percentage of cost each asset makes up of the total cost of the assets? appraisal values, then apply that to the 230,000. Buliding= 50% x 230,000=115,000 Land=35% x 230,000= 80,500 Equipment=15% x 230,000=34,500 Recording Use over productive life matching principle: Depreciation is a process of cost allocation. That is, the purpose of depreciation is to expense the cost of the asset over the years the asset is used to help generate revenues. Depreciation is NOT an attempt to show the asset?s current market value. Effect of recording depreciation on financial statements: Increase the depreciation expense-- net income decreases Increase the accumulated depreciation (contra asset) - total assets decrease Depreciation expense is based cost of asset and two estimates: useful life ? cost must be allocated over the periods benefiting from use of asset salvage value (or residual value) ? the amount expected to be obtained at disposal of asset Methods of calculating depreciation expense 1. straight line method, allocates expense evenly over useful life expense each year = Cost ? salvage value Useful Life 2. units of activity method ? expense related to actual usage rather than time; life of asset expressed in terms of number of units asset will produce expense* = cost ? salvage value X units produced useful life in units in current period * asset cannot be depreciated to an amount less than its expected salvage value 3. accelerated method (i.e. double declining balance method), records more expense in early years of use expense = 2/life x book value** ** since book value changes each year, expense changes each year And again, asset cannot be depreciated to an amount less than expected salvage value 4. MACRS (and ACRS) ? method usually required by IRS for tax purposes (we will not need to calculate depreciation using MACRS) Example Depreciation methods A truck costing $16,000 was purchased on January 2, 2002. At the time of the purchase, the truck?s estimated salvage value was $1,000 and its estimated useful life was 5 years (100,000 miles). 1. Prepare a depreciation schedule for the life of the truck showing the depreciation expense, accumulated depreciation, and carrying value each year, using: a. straight line method. b. units of activity, assuming the truck was driven 10,000 miles in 2002, 20,000 miles in 2003, and 30,000 miles in 2004, 2005, and 2006 c. double declining balance method. 2. How would the depreciation expense change if the asset had been purchased April 1? Straight line deprecation- given as: (16000-1000)/(5)= 3000 yr Yr Depreciation expense Accumulated Depreciation Book Value 2002 3000 3000 13000 03 3000 6000 10,000 04 3000 9000 7,000 05 3000 12,000 4,000 06 3000 15,000 1,000 *book value is the undepreciated cost (cost minus accumulated depreciation) also know as carrying value Units of Activity- thinks about the usage of the asset Calculate a cost per unit: (cost minus salvage value divided by life of asset times the use) (16,000-1000) / (100,000) = 0.15 per mile Yr Depreciation expense Accumulated Depreciation Book Value 2002 1500 1500 14,500 03 3000 4500 11,500 04 4500 9000 7,000 05 4500 13,500 2,500 06 4500 18000 -2,000 *this won?t work because we can?t have a negative book value. Because we believe we will sell the truck for 1000, we can?t ever let book value drop below 1000. 06 1500 1500 1000 Double Declining Balance: 2/life in years X book value Yr Depreciation expense Accumulated Depreciation Book Value 2002 6400 6400 9600 03 3840 10240 5760 04 2304 12544 3456 If the truck was bought in april, then we just take 9/12 times years expense with straight line and double declining. This is not the case with units of activity, because expense depends on use, and not on time. Costs incurred after acquisition: Capital expenditure- something done to an asset to make it bigger, better, more efficient, extends capacity, extend the life of the asset- add to the asset account Revenue expenditures- regular routine maintenance that keeps an asset in original working condition- expense these as you incur the cost Disposal Assets may be sold for cash, exchanged for new assets, or scrapped To record the disposal of an asset: Record any depreciation expense to the date of disposal Zero out the asset and its accumulated depreciation Record any cash received Record any gain or loss (gain or loss is the difference between book value and cash received) Example National Express Delivery Company has a small truck that is no longer needed by the firm. The truck was purchased for $18,000 on January 2, Year 3 and had an estimated salvage value of $2,000 and an estimated useful life of 4 years. The disposal date of the truck is July 1, Year 5. 18000 ? 2000/ 4 = 4000 dollars per year Accumulated Depreciation= 4000 4000 2000 = 10000 BValue= 80000 Record the disposal of the truck under each of the following assumptions: a. The truck is sold for $8,000. Cash= 8000 AD= 10000 Truck was 18000 b. The truck is completed destroyed in an accident, and the company receives $1,500 as an insurance settlement. 1500 received 8000 book value Loss of 6500 Cash 1.5 AD 10 Loss 6.5 Truck 18 c. The truck is sold for $12,900. Cash 12.9 AD 10 truck gain 4.9 NATURAL RESOURCES Includes items such as oil deposits, timber, coal, and minerals. The expense associated with the use (consumption) of the natural resource is depletion. Depletion expense calculated based on a cost per unit of natural resource; expense is the cost per unit multiplied by number of units used (mined, cut, drilled, etc) ? similar to units of activity method Depletion expense = Acquisition cost of resource ? residual value X Units consumed Units of resource during period Example Aggie Sand and Gravel paid $400,000 for the mining rights to a gravel deposit. The deposit is expected to contain 1 million tons of gravel. What is the depletion rate for the gravel? 400,000 / 1,000,000= .40/ton Assuming 90,000 tons of gravel are mined and sold during the year, how much is Aggie?s depletion expense? 90,00 x .40 = 36,00 INTANGIBLE ASSETS Assets with no physical properties such as patents (not including research and development), copyrights, trademarks, organization costs, franchises; provide future economic benefits Intangible assets with definite life: expensed over useful life, expense associated with intangibles is amortization expense (similar to straight line depreciation) Goodwill ? appears on balance sheet only if purchased; not amortized on regular basis, instead is tested annually for impairment; if necessary asset is written down (decreased) buyer had goodwill on his balance sheet, Goodwill doesn?t get expensed automatically (Seller doesn?t have a dollar value for goodwill until someone pays more than market price for the business)