chapter 7 notes

Chapter 7

PPE and Intangibles

Types of Non-current Assets

2Copyright ©2014 Pearson Education.

Plant, Property and Equipment

(PPE)

Construction in Progress

Intangibles Investment Properties

PPE & Intangibles TerminologyAsset Account

(Balance Sheet)Related Expense Account

(Income Statement)

Property, Plant and Equipment

Freehold Land None

Leasehold land Depreciation

Buildings, Machinery & Equipment

Depreciation

Furniture & Fixtures Depreciation

Land Improvements Depreciation

Natural Resources Depletion

Intangibles

Intangibles with finite useful lives Amortization

Intangibles with indefinite useful lives

None3Copyright ©2014 Pearson Education.

Learning Objective 1Determine the cost of a PPE and account for depreciation


Measuring the Cost of a PPE


Sum of all costs incurred to ________________________________


Asset Costs included

Land Purchase price, commissions, survey & legal fees, and back property taxes paid; grading and removing unwanted buildings

Land Improvements Fencing, paving, security systems & lighting

Building – Constructed

Architectural fees, contractors’ charges, materials, labor, and overhead; interest on funds borrowed

Building – Purchased

Purchase price, broker’s commission, taxes paid and all costs to repair and renovate building

Equipment Purchase price, transportation, insurance in transit, sale tax, installation and testing

Lump-Sum (Basket) Purchases•Several assets purchased in a group at

one price•Total cost is allocated based on their

market values▫For Example, a building valued at

$2,700,000 and land valued at $300,000 are purchased together for $2,800,000.


AssetMarket value

Total market value

% of total

market value Total cost

Cost of each asset

Land $300,000 $3,000,000 10% $2,800,000

$_______

Building $2,700,000

$3,000,000 90% $2,800,000

$_______

Total $3,000,000

100% $_______

=

=

CAPITAL EXPENDITURES

EXPENSES

•Increase capacity or extend useful life

•________▫Cost is added to

an asset account

•Do not extend capacity or useful life

•Maintain or restore working order

•Cost is recorded as an expense


Distinction between the two requires judgment

Subsequent Costs

Depreciation

•Systematic allocation of cost of an asset over its life▫Charged to Income Statement

DR Depreciation Expense▫Cumulative amount charged is called

Accumulated Depreciation CR Accumulated Depreciation

•Supports _______________


Depreciation is NOT:


A fund to replace assets

Valuation process

Amounts Needed for Depreciation

Cost Useful life

Residual

value11Copyright ©2014 Pearson Education.


Asset costResidual

value

Depreciable amount

Depreciation Methods

Copyright ©2014 Pearson Education. 13

Straight-line

Units-of-production

Double-declining-balance

Straight-Line (SL)


Depreciable cost

Useful life, ______

Results in equal amount of expense

________


Accumulated

depreciation increases

Book value decreases

Asset’s final book value = Residual value

Estimated by manager

Units-of-Production (UOP)


Depreciable cost

Useful life ______

Depreciation per unit


Activity for period (units, miles)

Double-Declining-Balance (DDB)


DDB rateBook value

Straight-line rate x 2 (or

2/life in years)

Cost minus accumulated depreciation

Note: residual value is not subtracted here!

Residual Value: DDB


Ignored until final year

Final year depreciation

Book value at the beginning final

year

Residual value

DDB differences

•First-year depreciation is based on asset’s full cost

•Final year depreciation is a “plug” amount needed to reduce book value to residual value



1 2 3 4 5 $-

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

Depreciation Methods

S/LUOPDDB

Comparing Depreciation Methods

Choosing Depreciation Methods

Straight-line•Best for assets that

_______ __________•Best meets matching

principle

Units-of-production•Best for assets that

_______ __________

Double-declining-balance•Best for assets that

_______ __________ in useful life


Depreciation Methods Used by 170 IFRS Companies

22Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall.

Straight Line84%

Units of Production

9%

Others5%

Declining Balance2%

23Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

E7-19A

• West Side’s Pizza bought a used Nissan delivery van on January 2, 2010, for $19,000. The van was expected to remain in service for four years (36,000 miles). At the end of its useful life, West Side’s officials estimated that the van’s residual value would be $2,800. The van traveled 11,000 miles the first year, 13,000 miles the second year, 5,000 miles the third year, and 7,000 miles in the fourth year.

• What is the annual depreciation using the straight-line, units-of-production, or double-declining method?

Exercise 7-19A


Straight-line

Depreciable cost

Useful life, in years

____________

__________

____________depreciation expense per

year

Exercise 7-19A


Depreciable cost

Useful life in units


Units-of-production

____________

____________

_______ per mile



Activity for period (units, miles)

Exercise 7-19A Units-of-production

$_____ per mile

MilesDepreciation expense

11,000 $4,950

13,000 $5,850

5,000 $2,250

7,000 $3,150

Exercise 7-19A


DDB rate2/Life in

years

2/4 years50%

Year Book value

Depr. Exp. Accum. Depr.

Book value

1 19,000 9,500 9,500 9,5002 9,500 4,750 14,250 4,7503 4,750 2,37516,62

52,375

Less than residual value

2,8001,950 16,200

Double-declining-balance

Learning Objective TwoUnderstand additional issues related to accounting for PPE


Issues in Accounting for PPE


Income taxes affected by

depreciationLong lives

Alternative subsequent

measurement models

Gain and losses on

disposal of PPE

Depreciation for Tax Purposes


Tax savings can be reinvested in business

Tax deductions decrease tax payments

Accelerated deprecation provides fastest tax deductions

The government might not give companies discretion over which rates to use for depreciation. For example, Hong Kong and U.S.

Partial Year Depreciation


Annual depreciatio

n

Months from date of purchase to end of

year

12

We normally do not have to go further than 1 month.

Changing Useful Life


_________ depreciable book value

______Estimated remaining useful life

Impairment of PPE


•An asset is impaired when its carrying value is higher than its recoverable amount

• Recoverable amount is the higher of fair value less cost to sell and value in use.

• DR _________________ & CR _________________ __________________________________________

Measurement Subsequent to Initial Recognition


• An entity elects one out of two measurement models for each class of property

• Cost model:• carried ______ less any accumulated depreciation and

any accumulated impairment losses.

• Revaluation model:• carried at a ____________, less any subsequent

accumulated depreciation and subsequent accumulated impairment losses

• fair value of asset must be able to be measured reliably

Using Fully Depreciated Assets


• A fully depreciated asset is one that has reached the end of its estimated useful life.

• Book value is zero (or residual value)• Does not mean the equipment is worthless• Asset may be used for a few more years, but

depreciation __________________• When the company disposes of the equipment, it

will remove both the asset’s cost and its accumulated depreciation from the books.

Learning Objective ThreeAnalyze the effects of a PPE disposal


Disposal of PPE•First – Bring depreciation up-to-date to:

▫Measure asset’s final book value▫Record expense up to date of disposal

•Then – Remove asset and related accumulated depreciation account from books

•If asset is junked (0 sale value):▫Fully-depreciated and no residual value

No gain or loss▫If not full-depreciated and/or has a residual

value Loss equals ending book value 37Copyright ©2014 Pearson Education.

Selling a Plant Asset


If cash received is

greater than book value

GAIN

If cash received is less than

book value

LOSS

39Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

Exercise 7-23A

•Assume that on January 2, 2010, Maxwell of Michigan purchased fixtures for $8,800 cash, expecting the fixtures to remain in service five years. Maxwell has depreciated the fixtures on a double-declining-balance basis, with $1,300 estimated residual value. On August 31, 2011, Maxwell sold the fixtures for $2,900 cash.

•Record both the depreciation expense on the fixtures for 2011 and then the sale of the fixtures.

Exercise 7-23A


Year Beg. Book value

Depr. Exp. Accum. Depr.

End Book value

2010 8,800

2011

2/5-year life = 40% DDB

Rate

$5,280 x 40% x 8/12

Cash received: $2,900

Book value: $_______

___ = $___

Exercise 7-23A


JOURNAL

Date Accounts and explanation Debit Credit

Aug 31

Aug 31

Exchanging PPE•Old assets traded in for new assets

▫Nonmonetary exchange•Cost of plant asset received is equal the

fair values of assets given up▫Old asset and any cash paid

•Difference between fair value of old asset and its book value is a gain or loss▫Example: exchange old van with $5,000

book value ($8,000 cost and $3,000 accumulated depreciation) for a new truck with fair value of $10,000 and paying $3,000 cash. What is the journal entry?


Learning Objective FourAccount for natural resources and depletion


Natural Resources

•Include iron ore, oil and timber•Expensed through depletion

▫Similar to depreciation▫Computed like _______________

Must estimate how much can be produced


JOURNAL


Depletion expense

Accumulated depletion

Learning Objective FiveAccount for intangible assets and amortization


Intangible Assets•No physical form

▫Carry special rights▫Include patents, copyrights and franchises

•Two categories▫Finite lives

__________________ Straight-line method Intangible asset reduced directly (not against

accumulated amortization)▫Indefinite lives

__________________ Tested for loss in value (impairment)


Accounting for Specific Intangibles


Patents Copyrights

Trademarks and trade names

Franchises &

licensesGoodwill

Patents•Granted by government•Give holder exclusive right to produce

and sell an invention▫HK – 20 years or 8 years▫US – generally 20 years


Copyrights

•Granted by the government•Give holder exclusive rights to reproduce

and sell a book, musical composition, film or other work of art▫HK – Extend up to 50 years beyond

author’s life▫US – Extend up to 70 years beyond author’s

life


©

Trademarks and Trade Names•Distinctive identification of a product or

service▫Also include advertising slogans

•Useful life may be set by contract▫Or indefinite life

•Indicated by TM or ®▫HK – (renewal 10 year periods)▫US – (20 years + renewal 10 year periods)


Franchises and Licenses

•Granted by private business or government

•Give purchase right to sell a product or service with specified conditions

•Include restaurant chains and sports organizations

•Have indefinite life (if renewable)


Goodwill

•Defined as the excess of the purchase price of the company over the market value of its net assets▫Recorded only during the _______________

________•Represents earning power of company

purchased•__________, but subjected strict

impairment tests


Impairment of Intangible Asset•Decline in asset value•Write-down required if value of intangible

decreases below cost▫Reversal of goodwill impairment is not

allowed•Applies to all intangibles – both those with

finite lives and indefinite lives


JOURNAL


Impairment loss on intangible

Intangible asset

Research and Development Costs•Costs associated with creation of

intangible assets are classified into research phase and development phase.▫Research phase

Always expensed▫Development phase

Capitalized if criteria are met (IFRS) Generally, based on technical feasibility (Expensed, not capitalized, under US GAAP)


Learning Objective SixReport PPE transactions on the statement of cash flows


Plant Asset Transactions on the Cash Flow StatementItem Section DescriptionDepreciation Operating Added to net

income as a reconciling item

Sales of PPE Investing Cash proceeds from sales of PPE - inflow

Purchase of PPE Investing Cash purchases - outflow


chapter 7 notes

Documents

pearson education

pricetotal cost

useful lifemaintain

depreciable costuseful

asset accountdo

market valuesfor example

balance ddbcopyright

assets final book value