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Chapter 9 Handout 1. Long-Lived Assets Actively Used in Operations → Will not be used up within the next year 2. What are the two common categories of long-lived assets? a. Tangible: Physical Substance, also known as PP& E (property, plant & equipment) i. Land ii. Assets subject to depreciation 1. Buildings and equipment 2. Furniture and fixtures b. Intangible: No Physical Substance i. Value represented by rights that produce benefits. ii. Some assets have a limited life, such as patents and copyrights, are subject to amortization. iii. Some assets have an unlimited (or indefinite) life, such as goodwill and trademarks, are not amortized. 3. What is the term for recording costs as assets rather than as expenses? Capitalizing the cost 4. Distinguish between ordinary repairs and extraordinary repairs. How is each accounted for? a. Ordinary repairs and maintenance should be expensed. b. Extraordinary repairs and additions should be capitalized. 5. Depreciation Expense – allocation of costs, for assets that are capitalized, over their useful life a. Accumulated Depreciation – (contra asset) total depreciation recorded over all time periods b. Book value (Carrying Value) – acquisition cost of an asset minus its total accumulated depreciation c. In computing depreciation, three values must be known or estimated. i. Asset cost - all the costs capitalized for the asset, such as purchase price, sales tax, legal fees, and other related costs. ii. Residual value - This is an estimate of the amount that the company will get when it disposes of the asset. iii. Useful life - This is an estimate of the asset’s useful economic life to the company (rather than its economic life to all potential users). d. In computing depreciation, there are three different methods. List the methods and the formula associated with each method i. Straight Line: Cost-Residual Value x 1/Useful Life = Depreciation Expense per year ii. Units of Production: Cost – Residual x Actual production this period/ Estimated Total Production = Depreciation Expense for the period iii. Double-Declining Balance: Cost – Accumulated Depreciation x 2/ Useful Life = Depreciation Expense 6. Impairment – when future cash flows (benefits) fall below its book value (cost less accumulated depreciation) Calculation: Book value – Fair value = Impairment loss a. 2 steps to account for an asset impairment: i. Eliminate Accumulated Depreciation against the asset. ii. Write down the asset to its fair value by recording an Impairment Loss.

Chapter 9 Handout 7. Disposal a. May result in a gain (disposed of for more than BV) or a loss (disposed of for less than BV) b. 2 steps to dispose of a depreciable asset: i. Update Depreciation Expense & Accumulated Depreciation accounts. ii. Record the disposal. 8. Intangibles a. 2 ways to acquire: (1) purchase or (2) create b. Report purchased intangibles like PP&E (original cost + expenditures that get it ready for use). c. For intangibles developed internally, expense costs as incurred; legal fees are considered an asset. 9. Ratios a. Fixed Asset turnover ratio – measures the revenues generated for each dollar invested in fixed assets; Calculated as: Net Sales Revenues / Average Net Fixed Assets (higher=better)

Example: #1: Cost Allocation Charger Corp. purchased land as a factory site for $60,000. An old building on the property was demolished, and construction began on a new building. Costs incurred during the first year are listed below. Determine the amounts that the company should record in the Land and the Building accounts. Demolition of old building

$8,000

Sale of salvaged materials

(1,000)

Architect fees (for new bldg.)

15,000

Building construction costs

500,000

Legal fees (for title investigation of land)

2,000

Land: $69,000 = 60,000+ 8,000 + 2,000 – 1000

Property taxes on land (for 1st year)

3,000

Building: $515,000 = 500,000 + 15,000

**Property tax for the 1 year is an expense.

Example #2: Cost Allocation Whole Grain Bakery purchases an industrial bread machine for $25,000. In addition to the purchase price, the company makes the following expenditures: freight, $1,500; installation, $3,000; testing, $1,000; and property tax on the machine for the first year, $500. What is the initial cost of the bread machine? 25,000 cost + 1,500 freight + 3,000 installation + 1,000 testing = 30,500

Chapter 9 Handout Example #3 Depreciation E9-7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-in restaurants in San Marcos, TX, at a cost of $27,000. The equipment has an estimated residual value of $1,500. The equipment is expected to process 255,000 payments over its three-year useful life. Per year, expected payment transactions are 61,200, year 1; 140,250, year 2; and 53,550, year 3. Required: 1. Complete a depreciation schedule for each of the depreciation methods. a. Straight-Line b. Units-of-production c. Double-declining balance: a. Straight-line:

Income Statement

Year Computation At acquisition 1 ($27,000 - $1,500) x 1/3 2 ($27,000 - $1,500) x 1/3 3 ($27,000 - $1,500) x 1/3

Balance Sheet

Depreciation Expense

Cost

Accumulated Depreciation

$8,500 8,500 8,500

$27,000 27,000 27,000

$ 8,500 17,000 25,500

Book Value $27,000 18,500 10,000 1,500

b. Units-of-production: Year Computation* At acquisition 1 ($27,000 - $1,500) x 61,200/255,000 2 ($27,000 - $1,500) x 140,250/255,000 3 ($27,000 - $1,500) x 53,550/255,000

Depreciation Expense

Cost

Accumulated Depreciation

$ 6,120

$27,000

$ 6,120

Book Value $27,000 20,880

14,025

27,000

20,145

6,855

5,355

27,000

25,500

1,500

* Alternatively, units-of-production depreciation could be calculated using a depreciation rate per unit of output, computed as: ($27,000 – $1,500)  255,000 = $0.10 per unit of output. c. Double-declining balance: Year Computation At acquisition 1 ($27,000 - $0) x 2/3 2 ($27,000 - $18,000) x 2/3 3 ($27,000 - $24,000) x 2/3

Depreciation Expense

Cost

Accumulated Depreciation

$18,000 6,000 1,500*

$27,000 27,000 27,000

$18,000 24,000 25,500

Book Value $27,000 9,000 3,000 1,500

*Although ($27,000 - $24,000) x 2/3 = $2,000, because the ending book value must equal residual value ($1,500), only enough depreciation expense is recorded in year three to make the book value equal $1,500.

Chapter 9 Handout Example #4: Impairment After recording depreciation for the current year, Mahomes Media decided to discontinue using its production equipment. The equipment had cost $375,000, accumulated depreciation was $290,000, and its fair value (based on estimated future cash flows from selling the equipment) was $40,000. Determine whether the equipment is impaired and prepare the journal entries to record the impairment in asset, if any. BV 85,000 – FV 40,000 = Impairment Loss 45,000 JE 1 Accumulated Depreciation – Equipment

290,000

Equipment

290,000

JE 2 Impairment Loss

45,000

Equipment

45,000

Example #5: Disposal Mayfield Movers sold a delivery truck for $18,000. Mayfield had originally purchased the truck for $45,000 and had recorded depreciation for three years. Calculate the amount of gain or loss on disposal and prepare the journal entries to record the disposal of the truck, assuming that Accumulated Depreciation was (a) $30,000 and (b) $25,000. What are the accounting equation effects for each entry? a.

Asset Cost 45,000 -Acc. Dep (30,000) Book Value 15,000

Selling Price 18,000 -Book Value (15,000) Gain 3,000

Cash 18,000 Acc. Depr. 30,000 Equipment 45,000 Gain on Disposal 3,000

b.

Asset Cost 45,000 -Acc. Dep (25,000) Book Value 20,000

Selling Price 18,000 -Book Value (20,000) Loss (2,000)

Cash 18,000 Acc. Depr. 25,000 Loss on Disposal 2,000 Equipment 45,000

Example #6: Intangibles Big Company acquires all the outstanding stock of Little Company for $14 million. The fair value of Little Company’s assets is $11.3 million, and the fair value of their liabilities is $1.5 million. Calculate the amount paid for goodwill. Purchase price

14,000,000

-Fair Value of net assets (9,800,000) = 11,300,000-1,500,000 Goodwill

4,200,000

Example #7: Intangibles and Amortization Expense In early January, Burger Mania acquired 100% of the common stock of the Crispy Taco restaurant chain. The purchase price allocation included the following items: $4 million, patent; $3 million, trademark considered to have an indefinite useful life; and $5 million, goodwill. Burger Mania’s policy is to amortize intangible assets with finite useful lives using the straight-line method, no residual value, and a 5-year service life. What is the total amount of amortization expense that would appear in Burger Mania’s income statement for the first year ended December 31 related to these items? Patent 4,000,000 / 5 years = 800,000 amortization expense per year Trademark & Goodwill are not amortized because they have indefinite lives...