BUS210
Accounting for Investment Decisions:
Property, Plant, & Equipment & Intangibles
E9-18 T account analysis
The following financial information was taken from the records of Fredrickson and Peiffer.
a.
b.
Reconstruct the entry that recorded the sale of equipment during 2014.
How much equipment was purchased during 2014?
2014
2013
BALANCE SHEET:
Equipment
Less: Accumulated depreciation
Net book or carrying value
$26,900
$23,400
10,500
9,800
$16,400
$13,600
$3,800
$3,500
900
0
$4,300
0
INCOME STATEMENT:
Depreciation expense
Loss on sale of equipment
STATEMENT OF CASH FLOWS:
Cash received from sale of
equipment
BE9-3 Acquisition of Fixed Assets
The footnote was taken from the 2012 annual report of Johnson & Johnson (dollars in
millions).
a. Approximately how much was invested in land during 2012?
b. Why did accumulated depreciation increase during 2012?
c. J&J uses the straight-line method of depreciation. If the company
used an accelerated method, what effect would that decision have
on the balance sheet?
d. What dollar amount appeared on J&J’s 2012 balance sheet for PPE?
Land and land improvements
Building and building equipment
Machinery and equipment
Construction in progress
Less accumulated depreciation
2012
2011
$793
$754
$10,046
$9,389
21,075
19,182
2,740
2,504
$34,654
$31,829
18,557
17,090
$16,097
$14,739
E9-16 Reverse T-account
Based on the following:
a. How much cash was
collected on sale of
equipment?
b. Reconstruct the sale
entry.
2014
2013
$37,500
$32,700
Less AD
17,600
14,300
Book Value
19,900
18,400
$7,200
$6,800
2,100
0
BALANCE SHEET
Equipment
INCOME STATEMENT
Depreciation expense
Gain on sale
Acquisition - What Costs to Capitalize?
• General Rule:
– Capitalize (add to an asset account) the costs
to acquire the asset and to prepare it for its
intended use.
Dr. Asset (purchase price, sales tax,
delivery, installation, etc)
Cr. Cash, Notes Payable, etc
• Land
– Has indefinite life and therefore is not depreciated
– Historical Cost includes:
• Purchase price, Closing costs, Cost to get ready for intended
use (i.e., clearing, grading, soil testing, filling), permanent
improvements. (Note: Sale of salvaged materials reduces cost)
• Land Improvements
– Depreciable since “directly associated with building”
rather than “inextricably associated with land.” i.e. if
building replaced then these improvements would be
replaced or their costs would be incurred again.
– Have definite life and therefore are depreciated
– Fences, walls, parking lots, driveways
• Buildings
– Have definite life and therefore are depreciated
– Proportionate share of purchase price, or construction
cost, Closing Cost, Architect & Attorney fees
• Machinery, Equipment, Furniture & Fixtures
– Purchase price (net of cash discounts), Freight &
handling, Insurance while in transit, Installation
– Example: Server farm--Invoice cost, transportation,
assembly, installation, testing labor, any modifications
to building to get into working order.
Self Constructed Assets
What to Capitalize?
Direct Materials & Labor
Variable Overhead
Applied Fixed Overhead
Interest During Construction, if constructed
–for company’s own use
–by someone else and progress payments &/or deposit
are required
E9-1 Capitalized Cost and Depreciation Base
Lowery Inc. purchased new plant equipment on 1.1.2014. The company paid $920,000 for
the equipment, $62,000 for transportation, and $10,000 for insurance on the equipment
while in transit. The company also estimates that over the equipment’s useful life it will
require additional power, which will cause utility costs to increase $90,000. The equipment
has an estimated salvage value of $50,000.
a.
What amount should the company capitalize for this equipment on 1.1.2014?
b. What is the depreciation base of this equipment?
c.
What amount will be depreciated over the life of this equipment?
Lump Sum or Group Purchase of PPE
• Generally allocate price to the assets acquired
based on their relative fair market values. Up
to management to subjectively determine the
relative FMVs.
Group Purchase
Post-acquisition Expenditures:
Betterments or Maintenance?
• Betterments:
– Increase asset’s useful life
– Improve quality of asset’s output
– Increase quantity of asset’s output
– Reduce asset’s operating costs
• Maintenance
– maintain existing productivity or useful life
• Accounting treatment
– Betterments are capitalized [Capital expenditures]
– Maintenance expenditures are expensed[Revenue
expenditures]
Depreciation (Cost Allocation)
• Depreciation is a method of cost allocation.
– it is used to allocate the capitalized cost of
PP&E over the years benefited (matching)
– Note: depreciation will decrease the
carrying value of the asset, but it is not a
valuation technique (i.e., book value is not
market value)
Depreciation (Cost Allocation)
• Useful Life
• Salvage Value
• Depreciation methods
– (1) Activity (units-of-production)
– (2) Straight-line
– (3) Double-declining balance
– (4) 150 percent declining balance
– (5) Sum-of-the-years digits
– (6) MACRS (income tax depreciation)
– Under IFRS, depreciation accounting is very similar to
US GAAP.
Class Example
Given the following information regarding an
automobile purchased by the company on
January 2, 2008:
Cost to acquire = $10,000
Estimated life = 4 years
Estimated miles = 100,000 miles
Salvage value = $2,000
Calculate depreciation expense for the first two
years under each of the following methods.
(1) Units-of-Production (Activity)
Assume that the car was driven 20,000 miles in the year
2008, and 30,000 miles in 2009.
Annual depreciation =
Cost - Salvage Value x Current Activity
Total expected activity
For 2008= 10,000 - 2,000 x 20,000 = $1,600
100,000 miles
For 2009 = 10,000 - 2,000 x 30,000 = $2,400
100,000 miles
(2) Straight-Line
Annual depreciation =
Cost - Salvage
Estimated Life
= $10,000 - $2,000 = $2,000 per year
4 years
(3) Double-Declining Balance
DDB is an accelerated depreciation technique. It generates more
expense in the early years and less in the later years.
Annual depreciation = % (Cost - A/D) or %(Book Value)
where A/D is the accumulated depreciation for all prior years, and
the percentage is double the straight line rate, or 2 x 1/Estimate
life. In the example, the % = 2 x 1/4 = 2/4 = 50%.
Depreciation expense (D.E.)for:
2008 = 50% x (10,000 - 0) = $5,000
2009 = 50% x(10,000-5,000) = $2,500
Depreciation Example
Straight line
Your turn
Production/Units of Production/Activity Method
Your turn
Double declining balance or
200% declining balance
Your turn
E9-11 Depreciation Methods
Apex Trucking purchased a truck for $100,000 on 1.1.2014. The useful life was
estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000.
Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2:
35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the
end of the sixth year the truck was sold for $12,000.
Prepare the journal entries to record depreciation over the life of the truck and its
sale, assuming these methods:
a. Activity method
E9-11 Depreciation Methods
Apex Trucking purchased a truck for $100,000 on 1.1.2014. The useful life was
estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000.
Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2:
35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the
end of the sixth year the truck was sold for $12,000.
Prepare the journal entries to record depreciation over the life of the truck and its
sale, assuming these methods:
b.
Straight-line method
E9-11 Depreciation Methods
Apex Trucking purchased a truck for $100,000 on 1.1.2011. The useful life was
estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000.
Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2:
35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the
end of the sixth year the truck was sold for $12,000.
Prepare the journal entries to record depreciation over the life of the truck and its
sale, assuming these methods:
c.
Double declining balance
E9-9 Depreciation
Company buys a lathe on 1.1.14 for $300,000, estimates a 4 year life and can sell it at
the end of the fourth year for $60,000.
a.
Compute the annual depreciation expense using straight line and Double
declining balance methods.
b.
What are your considerations when choosing a depreciation method for financial
purposes?
MACRS
• MACRS (modified accelerated cost recovery
system) is a technique developed by the IRS for
tax reporting. It utilizes combinations of DDB,
150%DB, and SL to calculate a table of
percentages that can be applied to any
depreciable asset.
• Additionally, the IRS assumes no salvage value,
and a half year in the first and last year of
depreciation (some limitations on fourth quarter
purchases).
Change in Estimate
• The change in estimate affects only the current and future
years; we do not go back and change the previous years
that have already been posted.
• To calculate the new depreciation expense, first find out
how much depreciation has been posted (the Accumulated
Depreciation to date).
• Then use the following formula (to modify the straight-line
depreciation rate):
Remaining Book Value - New Est. Salvage
Remaining Estimated Life
Class Problem: Problem 9-7
Facts: In 2009 equipment costing $180,000, a salvage
value of $30,000, and a useful life of 10 years was
acquired. In the beginning of 2014, the company
added three years to the original useful-life estimate.
Two steps in solving:
(1)Determine Book Value at 1/1/14:
First: annual depr. expense =
(180,000-30,000)/10 years = 15,000/yr.
Then Accumulated Depr. to 1/1/14:
15,000 x 5 yrs = $75,000
So BV = 180,000 - 75,000 = 105,000
Class Problem: Problem 9-7
(2) Estimate depreciation expense for 2014,
assuming revised useful life:
BV - SV = 105,000 - 30,000 = $9,375 per yr.
Remaining life
10 - 5 +3
Journal entry:
Depreciation Expense
9,375
Accum. Depreciation
9,375
E9-7
Facts: In 2011 equipment costing $60,000, a salvage value of $12,000, and a useful
life of 5 years was acquired. In the beginning of 2014, the company added three
years to the original useful-life estimate.
a. Compute the book value of the machine as of 1.1.14 using the straight line
method.
b.
Prepare the journal entry to record 2014 depreciation expense.
PPE Disposals
• Depreciate PPE up to date of disposal.
• Remove PPE and its associated Accumulated
depreciation.
• Record receipt or payment of cash.
• Recognize any gain or lass on disposal (the
difference between to disposed asset’s book
value and the net value of the assets received).
• Types: Retirements (i.e., garbage, donation),
Sales, Trade-in on Dissimilar assets
Disposal: Retirement, Sale or Trade-In
• Retirement :
Dr. Loss (if not fully depreciated)
Dr. Acc Dep
Cr. Asset
• Sale:
Dr. Cash
Dr. Acc Dep
Cr. Asset
– Dr. Loss if BV > Cash or Cr. Gain if BV < Cash
• Trade-ins (for dissimilar assets): asset received should be valued
at
– the fair market value of assets given up, or
– the fair market value of the asset received,
• whichever is more evident and objectively determined
Sample Disposal Example
Using earlier example (cost = $10,000, salvage = $2,000).
After 4 years straight-line, $8,000 would be in A/D.
1. Assume the asset is retired (no cash received)
Loss on retirement
2,000
Accumulated Depr.
8,000
Automobiles
10,000
2. Assume the asset is sold for $3,000:
Cash
3,000
Accumulated Depr.
8,000
Automobiles
10,000
Gain on sale
1,000
Class Exercise: Exercise 9-15
Facts: Cost $25,000; Salvage $5,000, useful life 5 years. DDB used.
First calculate depreciation:
DDB % = 1/5 x 2 = 2/5 = 40%
Depr.
Expense
Book
Date
%
Cost - A/D
Value
1/1/12
25,000
12/31/12 40% (25,000 - 0)
= 10,000
15,000
12/31/13 40% (25,000-10,000) = 6,000
9,000
12/31/14 40% (25,000-16,000) = 3,600
5,400
12/31/15
PLUG
400*
5,000=SV
12/31/16
-05,000
*formula will exceed salvage value limit in 2015; just
depreciate $400, to salvage of $5,000.
Exercise 9-15, continued
(a) JE to scrap after 3 years, assumes that no cash is
received:
(b) JE to scrap after 5 years, assumes that no cash is
received:
Exercise 9-15, continued
(c) JE to sell for $8,000 after 3 years:
(d) JE if, after 5 years, the equipment and $28,000 traded for a
dissimilar asset with a fair market value of $30,000:
B. Intangible Assets
• Intangible assets are characterized by
(1) lack of physical evidence, and
(2) high uncertainty about future benefits.
• Cost is amortized over useful life (or legal life, if less),
but not to exceed 40 years.
• Adjusting Journal Entry if definite life:
Dr. Amortization expense
Cr. Intangible asset
XX
XX
• Exception is Goodwill which has an indefinite life, no
longer amortized but subject to impairment test. If
balance sheet value of asset is determined to exceed its
estimated fair market value, it is found to be impaired and
written down to its fair value.
• Under IFRS, revaluing intangibles is an option, but not a
requirement. Under US GAAP, revaluation is not an
option.
(1) Patents (20 year legal life)
• A company may capitalize the following
– the cost of acquiring an externally developed
patent.
– filing fees for internally or externally
developed patents.
– the legal fees for acquiring and successfully
defending a patent (internal or external).
• A company cannot capitalize the following:
– legal fees for unsuccessfully defending a
patent—expense instead
– Most research and development costs for an
internally developed patent--expense
Research and Development
Costs (for internally developed patents)
• Prior to 1974, most companies capitalized research and
development costs, then amortized the cost to future
periods.
• The FASB stated in SFAS 2 that, because “future
benefits” were uncertain, companies should expense all
R&D costs, unless they were related to tangible assets
(like buildings and equipment) that had multi-year lives.
• Companies complied with the standard, but for several
years many companies actually reduced their R&D
activities, because of concern for excess expense on the
income statement.
Other Intangible Assets
• (2) Copyrights
– granted for the life of the creator plus 70 years.
– capitalization rules similar to patents: costs of internally
developed copyright material cannot be capitalized.
• (3) Trademarks and Trade Names
– granted for 10 year periods, but indefinite renewals.
– some of design costs may be capitalized.
• (4) Organization Costs
– costs related to the creation of a company including
underwriting fees, legal and accounting, licenses, titles, etc.
– treatment similar to R&D costs; even though there may be
some future benefit, costs are expensed in the period
incurred.
(5) Software Development Costs (SFAS 86)
Capitalize the costs of developing software for sale or lease.
Expense software development costs if for internal use.
Other Intangible Assets - continued
(6) Goodwill (also discussed in Chapter 8)
– Recognized when one company purchases another company.
– Causes include reputation, good customer relations, superior
product development, etc.
– To calculate:
Purchase price paid for the company versus the fair market
value of the net assets acquired
= Goodwill (the excess amount paid)
– No longer amortized, instead subjected to an impairment test,
i.e.,
P9-13 Goodwill recognition
On 1.1.14 D Inc. purchased S Inc for $1.8 million. The total FMV of the individual
assets of S Inc is $1.35 million and the liabilities are valued on the balance sheet at
FMV. The balance sheet of S Inc at time of purchase:
Assets
Current assets
Long-lived assets
Total Assets
Liab & SHE
$650,000 Liabilities
330,000 SHE
$980,000 Total L&SHE
$250,000
730,000
$980,000
a.
b.
c.
How can the FMV of assets exceed the value on the BS?
Why would D Inc pay more for S Inc than the FMV of assets less liabilities?
Provide journal entry to record the purchase.
d.
In recent past goodwill was amortized over a period of time not to exceed 40
years. Why not?
IFRS vs. US GAAP: Revaluations to Fair Market Value
• One very important way in which IFRS differs from US GAAP
involves the use of fair market value as a basis for valuation
on the balance sheet.
– Under US GAAP, long-lived assets must be accounted for at
original cost less accumulated depreciation.
– Under IFRS, companies can either follow the US GAAP
method or they can periodically revalue their long-lived
assets to fair market value.
• In essence, US GAAP tends to follow a conservative “lower-ofcost-or-market” valuation principle, whereas IFRS allows
managers the option to more closely follow a pure market
valuation principle.
ID9-13 Google 10-K Disclosures
Answer the following questions:
a. What % of total assets do property, plant, and
equipment and long-lived assets in total make up?
b.
What is the largest category of property, plant, and equipment?
ID9-13 Google 10-K Disclosures
c.
How large is the depreciation and/or amortization expense relative to
sales, and why is it listed on the statement of cash flows?
ID9-13 Google 10-K Disclosures
Answer the following questions:
d. How much did NIKE invest in PPE, and how much cash did it receive from
disposals of PPE?
e. What is the largest intangible asset?