mcgraw-hill/irwin © the mcgraw-hill companies, inc., 2015 9- 1 chapter eight accounting for long-...
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McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015
9- 1
Chapter Eight
Accounting for Long-Term Operational
Assets
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9- 2
Chapter 8Long-Term
Operational Assets
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Classification of Operational Assets
Operational assets are used by a business to generate revenue.
Tangible operational assets have physical substance.– Property, Plant, and Equipment –
Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.
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Classification of Operational Assets
Tangible operational assets have physical substance.– Land – Has an infinite life and is not
subject to depreciation.
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Classification of Operational Assets
Tangible operational assets have physical substance.– Natural Resources – Mineral
deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life.
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Cost of Long-Term Assets
Buildings • Purchase price• Sales taxes• Title search and transfer document
costs• Realtor’s and attorney’s fees• Remodeling costs
Buildings • Purchase price• Sales taxes• Title search and transfer document
costs• Realtor’s and attorney’s fees• Remodeling costsEquipment • Purchase price (less
discounts)• Sales taxes• Delivery costs• Installation costs• Costs to adapt to
intended use
Equipment • Purchase price (less
discounts)• Sales taxes• Delivery costs• Installation costs• Costs to adapt to
intended use
Land • Purchase price• Sales taxes• Title search and transfer
document costs• Realtor’s and attorney’s
fees• Costs of removal of old
buildings• Grading costs
Land • Purchase price• Sales taxes• Title search and transfer
document costs• Realtor’s and attorney’s
fees• Costs of removal of old
buildings• Grading costs
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Classification of Operational Assets
Intangible operational assets lack physical substance and confer specific use rights on the owner. Patents Copyrights Franchises Licenses Trademarks
Burger QueenFranchise
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Basket Purchases of Assets
When land and building are purchased together, the land cost and the building cost are placed in separate accounts.
The total cost of the purchase is separated on the basis of relative market values.
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Example: On March 1, Arco Co. purchasedland and building for $100,000 cash. The appraised value of the building was $90,000 and the land was appraised at $30,000.
How much of the $100,000 purchase price will be allocated to each account?
Land = ? Building = ?
Basket Purchases of Assets
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Basket Purchases of Assets Fair Market Values:
Building $ 90,000Land $ 30,000
Total market value $120,000
Allocation of cost:
Building * $100,000 =Land * $100,000 =
Appraised Values
Total Cost
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Basket Purchases of Assets Fair Market Values:
Percent
Building $ 90,000 75%Land $ 30,000 25%Total market value $120,000
Allocation of cost:
Building * $100,000 =Land * $100,000 =
Total Cost
Appraised Values
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Basket Purchases of Assets Fair Market Values:
Percent
Building $ 90,000 75% Land $ 30,000 25%Total market value $120,000 100%
Allocation of cost:
Building * $100,000 =Land * $100,000 =
Total Cost
Appraised Values
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Basket Purchases of Assets Fair Market Values:
Percent
Building $ 90,000 75%Land $ 30,000 25%
Total market value $120,000 100%
Allocation of cost:
Building 75% * $100,000 =Land 25% * $100,000 =
Total Cost
Appraised Values
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Basket Purchases of Assets
Fair Market Values: Building $ 90,000Land $ 30,000
Total market value $120,000
Allocation of cost:
Building 75% * $100,000 = $75,000Land 25% * $100,000 = $25,000
Total Cost
Appraised Values
Allocated Cost
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Basket Purchases of Assets General Journal entry:
Building $ 75,000Land $ 25,000 Cash $100,000
Allocation of cost:
Building 75% * $100,000 = $75,000Land 25% * $100,000 = $25,000
Total CostAllocated
Cost
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Depreciation
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You’ve purchased an asset that will be used to benefit more than one year of operations. When you buy the asset you do NOT “expense” it. You postpone (defer) the recognition of the expense until you have used the asset over a period of time.
Recognizing an expenditure by spreading it over several years, allocating a part of the expense to each of several periods during which the asset is used, is called depreciation.
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Depreciation
The portion of the cost of an asset allocated to any one accounting period is called--DEPRECIATION EXPENSE
Depreciation of an asset is an allocation process--spreading the cost of an asset that benefits more than one accounting period over the estimated useful life of the asset.
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Example of Depreciation: ABC Sports Bar Co.
bought equipment for $55,000. The asset is expected to last five years and have a $10,000 salvage value at the end of its useful life. How will the purchase and use of the asset affect the financial statements?
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We want to allocate the cost of the asset to the income statement as an expense during the time period we use the asset. Why?
To comply with the MATCHING principle. Expenses incurred must be “matched” to the
same time period the revenues (from using this equipment) are recorded.
If we depreciate the asset using the STRAIGHT LINE method, we will divide the cost of the asset (minus any estimated salvage value) by the useful life:
(55,000-10,000)/5 yrs. = $9,000 depreciation expense each year.
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Effect on the financial statements:
Purchase of asset:Balance Sheet Increases assets (eg. Equip); may decrease “cash” asset
(thus, no effect on net assets) or may increase a liabilityIncome Statement
Statement of Changes in Stockholders’ Equity
Statement of Cash Flows
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Effect on the financial statements:Purchase of asset:
Balance Sheet Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.Income Statement No effectStatement of Changes in Stockholders’
Equity Statement of Cash Flows
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Effect on the financial statements:Purchase of asset:
Balance Sheet Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.Income Statement No effectStatement of Changes in Stockholders’
Equity No effectStatement of Cash Flows
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Effect on the financial statements:Purchase of asset:
Balance Sheet Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.Income Statement No effectStatement of Changes in Stockholders’
Equity No effectStatement of Cash Flows Depends on whether or not the asset was purchased for
cash. If cash is paid it is an Investing Activity cash flow.
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Balance Sheet Reduces the net value of the asset by increasing a
contra-asset account called accumulated depreciation Income Statement
Statement of Changes in Stockholders’ Equity
Statement of Cash Flows
Use of the asset:
Accumulated Depreciation is a Permanent (Asset) Account. It accumulates the depreciation expense each year of the asset’s useful life.
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Balance Sheet Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation Income Statement
Increase in depreciation expense reduces Net Income
Statement of Changes in Stockholders’ Equity
Statement of Cash Flows
Use of the asset:
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Balance Sheet Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation Income Statement
Increase in depreciation expense reduces Net Income Statement of Changes in Stockholders’ Equity
Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease.
Statement of Cash Flows
Use of the asset:
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Balance Sheet Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation Income Statement
Increase in depreciation expense reduces Net Income Statement of Changes in Stockholders’ Equity
Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease.
Statement of Cash Flows No cash involved. Depreciation is an adjusting entry.
Use of the asset:
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Depreciation Methods
1. Straight-line method - the same amount is depreciated each accounting period.
2. Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.
3. Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years.
1. Straight-line method - the same amount is depreciated each accounting period.
2. Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.
3. Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years.
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Example of Balance Sheet
AssetsCash 11,000$ Computer Equipment 55,000 Less: Accumulated Depreciation (9,000) 46,000 Total Assets 57,000$
LiabilitiesUnearned Revenue 12,000$
Stockholders' EquityCommn Stock 1,000$ Retained Earnings 44,000 Total Stockholders' Equity 45,000 Total Liabilities and Stockholders' Equity 57,000$
As of December 31, 2014
ABC Sports Bar, Inc.Balance Sheet
NetAsset
Balance
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Cost - Salvage Value
Life in Years
Straight-Line Method
Depreciation
Expense per Year=
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Straight-Line Method: Example
On January 1, 2013, equipment was purchased for $55,000 cash. The equipment has an estimated useful life of 5 years and an estimated Salvage value of $10,000.
What is the annual straight-line depreciation expense?
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Straight-Line Method: ExampleOn January 1, 2013, equipment was purchased for $55,000 cash. The equipment has an estimated useful life of 5 years and an estimated Salvage value of $10,000. = Rev. – Exp. = Net Inc. Cash Flow
Cash + Eqpt AccDep = Com. Stk. Ret. Earn.(55,000) 55,000 = NA = NA NA NA – NA = NA (55,000) IA
EquityAssets
Account Title Debit CreditEquipment 55,000 Cash 55,000
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Straight-Line Method: Example
Depreciation
Expense per Year=
Depreciation
Expense per Year=
Cost - Salvage Value
Life in Years
Depreciation
Expense per Year=
55,000 - 10,000
5
9,000
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Straight-Line Method: ExampleThe company use the equipment to generate $30,000 revenue for the period
= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow30,000 NA = NA + 30,000 30,000 – NA = 30,000 30,000 OA
NA (9,000) NA (9,000) NA – 9,000 (9,000) NA
Assets
Cash 30,000 Service revenue 30,000 Depreciation expense 9,000 Accumulated depreciation 9,000
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Units-of-Production Method
Step 1:
Depreciation Rate
= Cost - Salvage Value Estimated units of useful life
Depreciation Rate =Depreciation charge per each unit produced
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Units-of-Production Method
Depreciation Rate
= Cost - Salvage Value Estimated units of useful life
Step 1:
Step 2:
Depreciation Expense =
Depreciation Rate
×Number of
Units Producedfor the Year
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Given the same information [asset cost $55,000, has a salvage value of $10,000, has a useful life of five years] plus the fact that the asset is estimated to have a total productive capacity of 100,000 units during the useful life:
If 22,000 units were produced this year, what is the amount of depreciation expense?
Example of Units of Production Method
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Example of Production Method
Step 1:
Step 2:
Depreciation Expense = $ .45/unit x 22,000 = $9,900
Depreciation Rate
=
=Cost - salvage value
Productive output
$45,000
100,000
Dep. rate x units produced
= $.45Per unit
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Example of Production Method
If 15,000 units are produced during the second year of the asset’s life, what is the amount of depreciation expense?
$0.45 x 15,000 = $6,750 What is the Accumulated Depreciation at
the end of the second year?$9,900 + $6,750 = $16,650
What is the 12/31/05 Equip. Book Value?$55,000 cost - $16,650 Accum. Dep. = $38,350
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Accelerated depreciation methods result in more depreciation expense in the early years of an asset’s useful life and less depreciation expense in later years of the an asset’s useful life.
Accelerated Depreciation
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Double-Declining Balance Method
Declining-balance depreciation is based on the straight-line rate multiplied by an acceleration factor. – For example, when the acceleration
factor is 200 percent, the method is referred to as double-declining balance depreciation.
Declining-balance depreciation computations ignore salvage value.
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Double-Declining Balance Method
Annual Depreciation is calculated with the following formula:
Book Value × (2 × Straight-Line Rate)
$55,000 – 10,000 x 1 5 yrs
Straight-Line:
1 5
x 2 = 2 or 5
40%
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Using the same information from our earlier example [asset cost $55,000,
Salvage value is $10,000, and useful life is 5 years]:
Calculate the depreciation expense for the asset’s life.
Double-Declining-Balance Example
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Double-Declining-Balance Example
YearBeginning
Book Value DDB RateDeprec.Expense Accum Dep
End Bk Value
1 55,000 40% 22,000 22,000 33,000 2 33,000 40% 13,200 35,200 19,800 3 19,800
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Double-Declining-Balance Example
YearBeginning
Book Value DDB RateDeprec.Expense Accum Dep
End Bk Value
1 55,000 40% 22,000 22,000 33,000 2 33,000 40% 13,200 35,200 19,800 3 19,800 40% 7,920
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Double-Declining-Balance Example
YearBeginning
Book Value DDB RateDeprec.Expense Accum Dep
End Bk Value
1 55,000 40% 22,000 22,000 33,000 2 33,000 40% 13,200 35,200 19,800 3 19,800 40% 7,920 43,120 11,880 4 11,880 40% 4,752 47,872 7,128
Solution:4 11,880 1,880 45,000 10,000 5 10,000 0 0 10,000
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Comparison of Depreciation Methods
Straight-line Production* Double-Declining Bal. Dep. Accum. Dep. Accum. Dep. Accum.Year Exp. Dep. Exp. Dep. Exp. Dep.
1 9000 9000 9900 9900 22,000 22,000
2 9000 18000 6750 16650 13,200 35,200
3 9000 27000 11250 27900 7,920 43,120
4 9000 36000 11250 39150 1,8801 45,000
5 9000 45000 5850 45000 01 45,000
*Units produced were Yr 1= 22,000; Yr 2=15,000; Yrs 3&4=25,000 each; Yr. 5=13,000. [1 In yr. 4, didn’t use DDB formula. Wrote-off last 1,880.]
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Comparison of Depreciation Methods The total amount of depreciation recorded
over the useful life of an asset is the same regardless of the method used.
Depreciation expense recorded in any one period will vary according to method used.
The straight-line method is used for financial accounting purposes (“the books”) by about 95 percent of companies because it is easy to use and to explain to financial statement users.
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Disposal of
Operational Assets
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
5 9000 (9000) 9,000 (9000)
B 45,000 55,000 18,000 70,000 12,000 Closed out 45,000 B
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
5 9000 (9000) 9,000 (9000)
B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
5 9000 (9000) 9,000 (9000)
B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
6 6,000 (6000) 6,000 (6000)
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1. Update the depreciation on the asset to the date of disposal.
2. Record the disposal by . . . – Removing the asset cost (credit).– Removing the Accumulated Depreciation
(debit).– Recording cash received (debit) or cash paid
(credit).– Recording a loss (debit) or gain (credit).
Disposal of Operational Assets
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Compare cash received for the asset with the asset’s book value (BV).
– If cash greater than BV, record a gain (credit).– If cash less than BV, record a loss (debit).– If cash equals BV, no gain or loss.
Gain or Loss on Disposal?
asset for sale
How do we know if there is a Loss or Gain on the disposal?
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Compare cash received for the asset with the asset’s book value (BV).
Disposal of Operational Assets How do we know if there is a Loss or Gain on the disposal?
Cash received
Equipment, cost
Less: Accum. Dep.
Equip, Book Value
Gain (Loss)
$26,000
$55,000
24,000
31,000
$ (5,000)
- 5000.
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
5 9000 (9000) 9,000 (9000)
B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
6 6,000 (6000) 6,000 (6000)
7 26,000 (55,000) (24,000) (5000) 5,000 (5000) 26,000 IA
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Journalize the Disposal
Cash
Accumulated Depreciation (to remove)
Loss on Disposal of Equipment
Equipment (original cost)
What if there had been a GAIN on disposal?
The GAIN would be a CREDIT in the journal entry above (and there would be
more cash).
$26,000
24,000
5,000
55,000
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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis
1 70,000 70,000 70,000 FA
2 (55,000) 55,000 (55,000) IA
3 30,000 30000 30,000 30,000 30,000 OA
4 + 9000 (9000) 9,000 (9000)
B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B
5 9000 (9000) 9,000 (9000)
B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B
6 6,000 (6000) 6,000 (6000)
7 26,000 (55,000) (24,000) (5000) 5,000 (5000) 26,000 IA
Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’tCash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
B 71,000 0 0 70,000 1,000 Closed out 71,000 B
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What’s the result? - For Year 3How much depreciation expense is on the 2015 Income Statement?
$6,000
How much Gain or Loss is on the 2015 Income Statement?
$5,000 Loss on Disposal
How much Accumulated Deprec. is on the 12/31/15 Bal. Sheet?
$0 (We don’t have the equipment anymore.)
What is the equipment’s Book Value(or Carrying Value) at the end of 2015?
$0 (We don’t have the equipment anymore.)
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Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. (Could use straight-line depreciation.)
MACRS provides for rapid write-off of an asset’s cost in order to stimulate investment in modern facilities.
MACRS uses half-year convention and assumes no Salvage value.
Depreciation and Federal Income Tax
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Same purchase recorded previously:
On Jan. 1, 2013 equipment costing $55,000 was purchased. Estimated life = 5 yrs. Estimated Salvage value = $10,000.
Depreciation and Federal Income TaxMACRS example
Calculate the depreciation taxdeduction assuming the equipmentis classified as “5 year property.”
Note: See tax tables in your text for 5-Yr. and 7-Yr. properties.
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IRS Table yr.
% 1
20.00 2
32.00 3
19.20 4
11.52 5
11.52 6
5.76
Depreciation and Federal Income TaxMACRS example
Equipm’t Costx $55,000 =x 55,000 =x 55,000 =x 55,000 =x 55,000 =x 55,000 =
$11,000 17,600 10,560 6,336 6,336 3,168 $55,000
Depreciation Deduction
100% = 100%
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9- 65 Revising Estimates of Salvage Value or of Useful Life
When an estimate is revised, no changes are made to amounts reported in the past.
The new estimates are incorporated into the present and future calculations only.
Depreciation amounts are revised using the book value, estimated useful life and salvage value at beginning of the year of the revision.
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Revising Estimates of Salvage Value or of Useful Life - Example
On Jan. 1, 2013 the Goodview Co. purchased Equipment costing $55,000. It was estimated to last 5 years and have a $10,000 Salvage value. Straight-line depreciation ($9,000) has been used.
On Jan. 1, 2015 management determinedthat the equipment would last 4 years fromthis date, but would only be worth $5,000 atthe end of that time.
How much depreciation expense should be recorded each year starting on Dec. 31, 2015?
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Revising Estimates of Salvage Value or of Useful Life - Example
The equipment has already been depreciated two years (‘08 and ‘09) at $9,000 per year. So, Accumulated Depreciation has an $18,000 balance at the beginning of 2015.
Original Cost $55,000
Less: Accum. Dep. 18,000
= Book value, Jan. 1, ‘2015 37,000
Less: Revised Salvage Value -5,000
= Remainder to be depreciated 32,000
Divided by Remaining life 4 yrs.
= New annual Depreciation expense $ 8,000
Starting in 2015
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Continuing Expenditures for Plant Assets
Costs That Are ExpensedThe cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume the company spent $500 cash for routine maintenance on machinery.
Account Title Debit CreditRepairs Expense 500 Cash 500
Assets = Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow
Cash Ret. Earn.(500) = NA + (500) NA – 500 = (500) (500) OA
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Continuing Expenditures for Plant Assets
Expenditures made to keep an asset in good working order are expensed in the period in which they are incurred. (normally expected repairs & maintenance)
Substantial costs spent to (1) improve the quality or (2) extend the life of an asset are capitalized.
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Accounting for capital expenditures:Extraordinary Repairs Ex: Overhaul Extend the life?
– viewed as canceling some of the previous depreciation
– journal entry to reduce (debit) accumulated depreciation
– new depreciation amount will be calculated using the revision approach.
BettermentsEx: Attach snowplow to
truck owned for 2 years.
Improve the quality?– viewed as an
additional cost of the equipment
– journal entry to increase (debit) the cost of the asset
– new depreciation amount will be calculated using the revision approach.
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Extraordinary Expenditure Extend Useful Life Improve Quality
Over-haul Engine
Original Cost
Add Attach-ment
EqptCost
10,000
AccumDeprec
4,000
Net Book Value 6,000
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Extraordinary Expenditure Extend Useful Life Improve Quality
Over-haul Engine
Original Cost
Add Attach-ment
EqptCost
10,000 10,000
AccumDeprec 2,000 = +2,000
4,000
Net Book Value 8,000 6,000
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Extraordinary Expenditure Extend Useful Life Improve Quality
Over-haul Engine
Original Cost
Add Attach-ment
EqptCost
10,000 10,000 +2,000 = 12,000
AccumDeprec 2,000 = +2,000
4,000 4,000
Net Book Value 8,000 6,000 8,000
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Natural Resources Assets supplied by nature
– Examples: gold, oil, and coal
Presented on balance sheet as non-current assets at cost minus all depletion to date.
Total cost of the asset is the cost of acquisition, exploration and development.
Cost is “written-off” as “Depletion Expense” over periods that related revenues are earned. (Usually, units-of-production method.)
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Natural Resources
A depletion rate is calculated usingthe units-of-production method.
Depletion Cost Per Unit Is Calculated As Follows:
Total Cost of Natural Resource
Estimated Number of Available Unitsof Natural Resource
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Natural Resources
Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons
of coal. After all coal is extracted the land is not expected to have any salvage value. During 2006, the
company extracted and sold 500,000 tons of coal.
$10,000,000 – $05,000,000 tons
= $2.00 per ton extracted and sold
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Natural Resources
= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow
Cash + Coal Mine(10,000,000) 10,000,000 = NA + NA NA – NA = NA (10,000,000) IA
NA (1,000,000) NA (1,000,000) NA – 1,000,000 (1,000,000) NA
Assets
Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons of coal. After all coal is extracted the land is not expected to
have any salvage value. During 2006, the company extracted and sold 500,000 tons of coal.
Account Title Debit CreditCoal Mine 10,000,000 Cash 10,000,000
Depletion Expense 1,000,000 Coal Mine 1,000,000
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Intangible Assets
Noncurrent assets without physical substance that confer certain rights and privileges on the owner of the asset. – Examples: patents, copyrights, franchises
and licenses, leaseholds, leasehold improvements, trademarks, and goodwill.
Purchased intangible assets are recorded at cost.
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Two Categories of Intangible Assets
Intangible assets with IDENTIFIABLE useful lives.– e.g. Patents and Copyrights They have a legal life, BUT they MAY become obsolete or worthless before their legal live is over.
Intangible assets with INDEFINITE useful lives. – e.g. Goodwill, Franchise, Trademark
How long will the “name” of a restaurant keep attracting customers if new owners don’t serve good food and provide good service?
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Intangible Assets with IDENTIFIABLE Useful Lives
Amortize (write-off) over the shorter of their useful life or legal life.
Normally the straight-line method is used and the asset is reported on the balance sheet at book value without a related accumulated amortization account.
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Intangible Assets: Patents A patent is an exclusive right granted by
the federal government to sell or manufacture an invention.
A patent is amortized over the shorter of its useful life or 17-year legal life.
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Intangible Assets with IDENTIFIABLE Useful Lives
Example: (1) A patent is purchased from a company for $20,000. (2) When purchased, there were 15 years remaining of the 17 year legal life, but management estimates that new technology will make this patent obsolete in 4 years. ($20,000/4=$5,000)
INCOME STATEMENT CASHFLOW
= + EQUITY STATEMENTAccts Com. Ret. Net OA,IA,FA
Cash + Patent = Pay. + Stk. + Earn. Rev. - Exp. = Inc. $ amt
BB 30,000 22,000 8,000 30,000 bal.
1 (20,000) 20,000 (20,000) IA
2 (5,000) (5,000) 5,000 (5,000)
EB 10,000 + 15,000 = - + 22,000 + 3,000 - - 5,000 = (5,000) 10,000 bal.
Patent 20,000 Amortization Expense 5,000
Cash 20000 Patent 5000
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Intangible Assets: Goodwill Goodwill is the added value of a business that is
attributable to favorable factors such as a good reputation, location, and superior products.
Goodwill must be PURCHASED by acquiring an existing business at a cost that is higher than the Fair Market Value of its physical assets (minus any liabilities assumed by the buying company).
Goodwill has an INDEFINITE useful life, so it must be tested for IMPAIRMENT each year.
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Intangible Assets with INDEFINITE Useful Lives
Must be tested for IMPAIRMENT each year. If the fair market value of the intangible asset is
less than its book value, the value has been IMPAIRED (reduced).
To reduce the intangible asset to its new lower fair value an IMPAIRMENT LOSS is recorded and reported on the Income Statement. The intangible asset is reduced by the same amount.
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Intangible Assets: Goodwill (Example)
Winona Co. purchased Rushford Co. by paying $1,500 cash for all of its assets, but also agreeing to assume its liabilities.
Individual company balance sheets before purchase: Rushford Co. Winona Co.Assets: Liab.-A/P 200 Assets: Liab.-A/P 1000Eq.,net 1000 C.Cap. 500 Cash 2000 C.Cap.
3000 Ret.Earn 300 Eq.,net 7000 Ret.Earn
5000T. Assets 1000 T. L&Eq.1000 T.Assets 9000 T. L&Eq. 9000
An appraiser says the Fair Market Value of Rushford’s assets is $1,300.
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Intangible Assets: Goodwill (example)
Cash Paid
+ Liab. Assumed
= Total cost
- FMV of Assets Acquired
= Goodwill purchased
Calculation of Goodwill
$1,500
200
1,700
1,300
$ 400
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Stockholders’
Equity
For
Corporations
Let’s Take a Quick Look at a Chapter 11
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Corporations
A corporation is a popular form of business because . . . It is simple for individuals to purchase
small amounts of stock.It allows for an easy transfer of
ownership through established markets, like the New York Stock Exchange.
It provides stockholders with limited liability.
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Corporations Because a corporation is a separate
legal entity, it can . . . – Own assets.– Incur liabilities.– Sue and be sued.– Enter into contracts independent of the
stockholder owners.
Many Americans own stock through a mutual fund or pension program.
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Ownership of a Corporation
Owners of common stock generally receive the following rights:– Voting (in person or by proxy).– Distributions of profits (in the form of Dividends).
– Distributions of assets in a liquidation.– Offers to purchase shares of a new stock
issue (pro rata basis).
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Creating a Corporation
State laws govern the creation of corporations.
An application for a charter (or articles of incorporation) must include the corporation’s name and purpose, kinds and amounts of capital (common) stock authorized, and other detailed information.
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Creating a Corporation
Once the state issues a charter, the stockholders elect a board of directors.
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Authorized, Issued, and Outstanding Capital Stock
The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.
AuthorizedShares
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Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
Issued shares have been
sold.
Unissued shares have
never been sold.
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Authorized, Issued, and Outstanding Capital Stock
AuthorizedShares
UnissuedShares
OutstandingShares
owned by stockholders.
IssuedShares
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Authorized, Issued, and Outstanding Capital Stock
AuthorizedShares
UnissuedShares
TreasuryShares
OutstandingShares
owned by stockholders.
IssuedShares
reacquired by the corporation.
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Common Stock
Basic voting stock of the corporation Ranks after preferred stock for
dividend and liquidation distribution. Dividend rates are determined by the
board of directors based on the corporation’s profitability and other factors.
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Chapter 8 (and a little 11)
The End