Accounting For Managers
Professor ZHOU Ning
SCHOOL OF ECONOMICS AND MANAGEMENT
BEIHANG UNIVERSITY
[email protected]
Chapter 7
Long-Lived Non-monetary
Assets and Their
Amortization
The objectives of chapter 7





Plant and equipment: acquisition
Accounting for depreciation
Plant and equipment: disposal
Natural resources
Intangible assets
7-3
Types of Long-Lived Assets

Tangible asset



Asset with physical substance
Property, plant, and equipment = fixed
asset.
Intangible asset


Intellectual property.
No physical substance

Examples are patent rights, copyrights
7-4
Amortization


View capital asset as bundle of services.
Similar to prepaid expenses, cost is
expensed as company benefits from
services.
7-5
Types of Long-Lived Assets
7-6
Depreciation



Gradual conversion of cost into expense.
Depreciation is a cost consumed by an
entity during an accounting period.
Systematic allocation of original
cost of an asset to periods in which
asset provides benefit to the entity.
7-7
Definitions





Deterioration = physical process of wearing out.
Obsolescence = loss of usefulness because of
change in technology or tastes.
Physical life = time until asset wears out.
Service life = shorter of either time until asset
becomes obsolete or time until asset wears out.
Book value = net book value = original cost accumulated depreciation to date.
7-8
Judgments required


Service life of asset.
Residual value at the end of its service life.


Net cost = original cost - residual value.
Method of depreciation used to allocate
cost over useful life of asset.
7-9
Depreciation methods

Straight line method:

Accelerated methods:



Declining balance methods.
Sum of the years’ or years’ digits methods.
Units of production method
7-10
Declining Balance Method

Depreciation = book value *
depreciation rate.

Double declining balance method = book
value * 2 * straight line rate.
7-11
Years digits method


Depreciation for first year = (cost residual value) * n / SYD.
Depreciation for second year = (cost residual value) * (n - 1) / SYD.
7-12
Depreciation methods
7-13
Units of production method

depreciation rate

Eg. Net cost of truck=$60,000
expected service life=300,000 miles
depreciation rate=$60,000/300,000=20%
if truck traveled 50,000miles in a year, the
depreciation expense=50,000X20%=$10,000
7-14
Choice of Depreciation method



Straight-line, accelerated, and units-ofproduction-has its own conceptual basis.
Theoretically, different methods would apply
to different types of assets. In practice, the
method usually chosen is straight-line.
Income tax consideration

Accelerated depreciation: receiving as quickly as
possible the tax saving
7-15
Depreciation Accounting

Accumulated depreciation: contra-asset
account is maintained for the cumulative
amount of depreciation.

Eg. On Jan. 1,2006, company A acquire an building
for $1,000,000 and estimated service life of 40
years and zero residual value. Management decided
to depreciate this building on straight-line basis.
=$1,000,000/40 yrs.=$25,000/yr.
7-16
Depreciation Accounting

How to record this depreciation in the financial
accounting records.
(1) Dec.31,2006
Building, at cost
Less: accumulated depreciation
building, net
$1,000,000
25,000
(2) Dec.31,2007
Building, at cost
Less: accumulated depreciation
building, net
$1,000,000
50,000
$975,000
$950,000
Book value
7-17
Depreciation Accounting

How to record this depreciation in the financial
accounting records.
To income statement
(3) Annual journal entry for depreciation
Depreciation expense
$25,000
Accumulated depreciation
$25,000
(4) Fully depreciation, Dec. 31, 2046
Building, at cost
Less: accumulated depreciation
building, net
$1,000,000
1,000,000
$0
7-18
Plant and Equipment: Disposal

Sale of building:



Remove cost and accumulated depreciation.
 Reminder: book value = cost - accumulated
depreciation.
Gain or (loss) = Selling price of asset - book value.
 Gain or loss in current period income statement.
Cost = market value at time of purchase.
7-19
Plant and Equipment:
Disposal Example

Suppose that at the end of 10 years company A sells
its building for $750,000 (book value, back to the
case of slice 20)
Dr. Dec.31,2016
Building, at cost
Less: accumulated depreciation
building, net
Dr. Cash
Accumulated Depreciation
Cr. Building
$1,000,000
250,000
$750,000
$750,000
250,000
$1,000,000
7-20
Plant and Equipment:
Disposal Example

Suppose that at the end of 10 years company A
sells its building for $650,000 less than
$750,000(book value), or $850 more than its book
value
Dr. Cash
Accumulated Depreciation
Loss on sale of building
Cr. Building
Dr. Cash
Accumulated Depreciation
Cr. Gain on sale of building
Building
$650,000
250,000
100,000
$1,000,000
$850,000
250,000
$100,000
1,000,000
7-21
Impaired Assets


Impaired if remaining benefits, as measured
by sum of future cash flows generated by use
of asset, is less than its book value.
If entity expects to hold asset:


Write asset down to fair value
If entity expects to sell asset:

Write asset down to lower of cost or fair value less
cost of disposal.
7-22
Natural Resources


Measure cost same as other assets.
Oil exploration costs:
 Full cost method:


Successful efforts method:


All costs of exploration allocated to and capitalized
as the value of reserves discovered during the year.
Only capitalize costs involved with successful efforts
(oil reserves that are discovered).
Both allowed under GAAP.
7-23
Natural Resources Example

A petroleum company explores 10 locations, incurring
costs of $10 million at each. It discovers oil and gas
reserves at 3 of these location.
 Full cost method:
Dr. Oil and gas reserves , at cost
Cr. cash

$100,000,000
$100,000,000
Successful efforts method:
Dr. Oil and gas reserves , at cost
explore expense
Cr. cash
$30,000,000
$70,000,000
$100,000,000
7-24
Depletion

Depletion: the process of amortizing the costs of natural
resources in the accounting periods benefited.
 Units of production method ordinarily used.

If an property cost $250 million and is estimated to
contain 50 million barrels of oil, the depletion rate is
$5 per barrel; the total depletion for a year in which 8
million barrels were produced would be $40 million.
7-25
Internally Developed or Acquired


Internally developed are expensed as
incurred.
Acquired are capitalized.
7-26
Categories of Intangibles



Intangible assets with limited lives.
Intangible assets with indefinite lives.
Goodwill.
7-27
Intangible Assets Limited Useful Life


Examples: patents and copyrights.
If purchased, recorded at cost.





Amortized over useful life.
Useful life can equal or be shorter than legal life.
Amortization should reflect the pattern in which
the economic benefits are consumed.
Straight line if pattern cannot be determined.
If developed internally, expense as incurred.
7-28
Intangibles with Indefinite Useful Lives


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
Example: renewable broadcast license.
Considered indefinite if no legal, regulatory,
contractual, competitive or other limiting
factors.
Not amortized.
Tested for impairment.
If determined to be impaired, it is written
down to realizable value and charged against
income.
7-29
Goodwill



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
When one company buys another.
Goodwill = Purchase price of company – fair value of
net assets.
 Net assets include tangible assets and recognized
intangible assets net of liabilities assumed by the
purchaser.
Recorded as an asset upon acquisition.
Not amortized.
Annual impairment test.
Any write down is charged against income.
7-30
Goodwill Example

Company A acquire all the assets of Company B,
giving Company B $1,500,000 cash. Company B has
cash of $50,000, accounts receivable that are
believed to have a realizable value of $60,000,and
other acquired assets other than goodwill that are
estimated to have a fair value of $1,100,000. The
amount of goodwill is calculated as follows:
Dr. Total purchase price
less
cash
accounts receivable
other acquired assets
Goodwill
$1,500,000
$50,000
60,000
1,100,000
1,210,000
$ 290,000
7-31
Intangible Assets with Limited Lives

Examples: patents and copyrights.

If purchased, recorded at cost.



Amortized over useful life.
Useful life can equal or be shorter than
legal life
If developed internally, expense as incurred.
7-32
Start-up Costs

Start-up Costs in pre-operating period.

Expense or

Capitalize and amortize over a short period
(rarely more than 5 years).
7-33
Research & Development (R&D) Costs

Costs incurred to:


GAAP:


Expense since future benefits uncertain.
Argument for capitalizing:


Develop new knowledge, products or improve
goods, processes, or services.
Matching concept.
Argument for immediate expensing:

Conservatism, objectivity.
7-34
Analysis of Nonmonetary Assets

To estimate:
7-35
Summary of Chapter 7





Plant and equipment: acquisition
Accounting for depreciation
Plant and equipment: disposal
Natural resources
Intangible assets
7-36
Assignments of Chapter 7


Problem 7-1
Problem 7-3
7-37
Thank you
7-38