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					        Chapter 9:
Long-lived Assets and Cost
         Allocation




                             1
    Long-lived Assets and Cost
             Allocation
A. Property, Plant, and Equipment
       - Depreciation
B. Intangible Assets
       - Amortization




                                    2
 A. Overview of Accounting for
 Property, Plant, and Equipment

 Acquisition         Use            Disposal



 1. What        2. Depreciation    4. Retirement
 costs to      3.Postacquisition       or Sale
capitalize?      expenditures




                                                   3
      1. 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.
 Note: For all acquisitions, part of the cost is the
  purchase price, specifically the “cash equivalent”
  purchase price (the amount we would pay if we
  paid cash). This excludes any cost of financing
  the purchase (interest expense).7

                                                       4
    1.    What Costs to Capitalize?
 Land
  – purchase price, clearing costs, survey
    costs, back taxes, closing costs, some
    landscaping (if permanent in nature).
 Land improvements
  – purchase price, for some landscaping
    (temporary), parking lots, sidewalks, etc.




                                                 5
      1.    What Costs to Capitalize?
 Machinery and equipment
  – purchase price, freight, installation,
    assembly, trial runs, testing and inspection
    during set up.
 Buildings
  – purchase price (or cost to construct),
    closing costs, attorney’s fees, building
    permits, etc.



                                               6
          1. What Costs to Capitalize

   Self-constructed assets
    – include cost of materials, labor, and
      overhead.
    – may also include interest cost during
      construction. The interest costs are
      calculated under specific rules, based on
      the length of time of the construction
      period, and the borrowing rates of the
      company.

                                                  7
      Class Exercise: Exercise 9-3
                                    Land
(a)               Land         Improvement          Building
Purch. tract    90,000
Raze whse.      10,000
Sold scrap      (7,000)
Construct bldg.                                     140,000
Drive & park. lot                   32,000
Landscaping 4,000*
Totals          97,000              32,000          140,000
*Since permanent (like trees), add to land; if not permanent
(like annual plants), add to land improvement so that it may
be depreciated.
                                                               8
   Class Exercise: Exercise 9-3

(b) Depreciation expense, first year:
   Land - none; land is not depreciated.
   Land Improvements:
     $32,000 / 20 years = $1,600 per year
   Building:
     $140,000 / 20 years = $7,000 per year




                                             9
                2. Depreciation
   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)

                                                      10
              2. Depreciation
   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)


                                            11
             Class Example
Given the following information regarding an
 automobile purchased by the company on
 January 2, 2005:
    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.

                                               12
      (1) Units-of-Production (Activity)
Assume that the car was driven 20,000 miles in the
  year 2005, and 30,000 miles in 2006.
Annual depreciation =
 Cost - Salvage Value       x Current Activity
 Total expected activity

For 2005= 10,000 - 2,000 x 20,000 = $1,600
          100,000 miles

For 2006 = 10,000 - 2,000 x 30,000 = $2,400
           100,000 miles

                                                     13
           (2) Straight-Line


                        Cost - Salvage
Annual depreciation =
                         Estimated Life


 =   $10,000 - $2,000 = $2,000 per year
          4 years




                                          14
      (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)
 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:
   2005 = 50% x (10,000 - 0) = $5,000
   2006 = 50% x(10,000-5,000) = $2,500
                                                       15
       (4) 150% Declining Balance
150%DB is another accelerated depreciation
  technique. It also generates more expense in the
  early years and less in the later years.
    Annual depreciation = % (Cost - A/D)
 where A/D is the accumulated depreciation for all
  prior years, and the percentage is 1.5 times the
  straight line rate, or
   1.5 x 1/Estimate life. In the example, the % =
  1.5 x 1/4 = 37.5%.
Depreciation expense (D.E.)for:
   2005 = 37.5% x (10,000 - 0) = $3,750
   2006 = 37.5% x(10,000-3,750) = $2,344
                                                 16
         (5) Sum-of-the-years Digits
SYD is another accelerated technique that calculates
  more expense in early years and less in later
  years.
  Annual depreciation = Fraction x (Cost-Salvage)
 where the fraction is calculated as follows:
  Numerator = declining years (highest first)
  Denominator = sum of the years digits
In the class example, the denominator is
  4+3+2+1 = 10
D.E. for 2005 =4/10(10,000-2,000) = $3,200
D.E. for 2006 = 3/10(10,000-2,000) = $2,400

                                                  17
                (6) 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).

                                             18
             (6) MACRS continued
Example of MACRS for a 5 year category. Assume an
  asset purchased for $1,000 sometime during 2005.
  The IRS uses DDB for the first 3 years (remember, no
  salvage and 1/2 year in the first year), then switches to
  SL for later years (see next page)to stretch it out to 5
  full years. DDB % = 2 x 1/5 = 2/5 = 40%.
DE 2005 =40%(1,000 - 0) x1/2 = $200 (20%)
DE 2006 = 40%(1,000-200)      = $320 (32%)
DE 2007 = 40%(1,000 - 520) = $192 (19.2%)
(Now A/D = 712, and BV =1,000 - 712 = 288)
DE 2008 = 288/2.5 yrs = $115.20 (11.52%)
DE 2009 =             = $115.20 (11.52%)
DE 2010 = (1/2)x 115.20 = $57.60 (5.76 %)

                                                          19
           (6) MACRS continued
 Note that the switch is made in 2007. This is the
  point where the straight line depreciation for the
  year is greater than or equal to the accelerated
  depreciation.
 If you calculate the depreciation expense using
  DDB for 2007, you would get:
          40%(1,000 - 712) = 115.2
 This is the point where straight line and DDB
  cross. After this point, DDB will be less than SL
  for the remaining years.
 This is the point where the IRS, in its schedules,
  switches to straight line, to “stretch” the
  depreciation out to the total years of life.

                                                       20
            (6) MACRS - continued
 Using  the previous calculations, the IRS developed
  a comprehensive set of percentages for all
  companies to use for depreciation expense for tax
  purposes.
 The categories are predefined by the IRS, and all
  the company must do is figure out which category
  each asset fits into.
 For example, automobiles fit into the five year
  category. The company would take the cost of the
  automobile (ignoring salvage), and multiply it by the
  indicated percentage to get the depreciation
  expense for the year (for calculation of income tax
  payable).
 The tables on the next page are excerpted from the
  IRS tables.                                         21
  MACRS Tables - selected years
Yr.   3 years   5 years   7 years   10 years
 1    33.33%    20.00%    14.29%    10.00%
 2    44.45     32.00     24.49     18.00
 3    14.81     19.20     17.49     14.40
 4     7.41     11.52     12.49     11.52
 5              11.52      8.93      9.22
 6               5.76      8.92      7.37
 7                         8.93      6.55
 8                         4.46      6.55
 9                                   6.56
10                                   6.55
11                                   3.28

                                               22
    Depreciation - change in estimate
 Because depreciation is an estimate, and
  two of the three components are subject to
  variability, sometimes we need to make a
  change in estimate (either in the estimated
  life or the estimated salvage).
 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.

                                                23
    Change in Estimate - continued
 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


                                              24
    Class Problem: Problem 9-7
(a)Book Value at 1/1/05:
   First: annual depr. expense =
     (180-30)/10 = 15/yr.
   Then Accumulated Depr. to 1/1/05:
     15 x 5 yrs = $75,000
   So BV = 180,000 - 75,000 = 105,000



                                        25
     Class Problem: Problem 9-7
(b) Estimate for 2005, 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



                                             26
    3. Postacquisition 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
    – Maintenance expenditures are expensed

                                                      27
    4. Disposal: Retirement, Sale or
                Trade-In
 Retirement - remove the asset and related A/D. If
  not fully depreciated, recognize loss.
 Sale - remove the asset and related A/D, then
  recognize cash received. The difference is a gain
  or loss.
 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.
                                                      28
         4. Disposal - continued
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
                                                        29
     Class Exercise: Exercise 9-15

First calculate depreciation:
DDB % = 1/5 x 2 = 2/5 = 40%
                                 Depr.     Book
Date     %     Cost - A/D      Expense Value
1/1/03                                    25,000
12/31/03 40% (25,000 - 0)     = 10,000 15,000
12/31/04 40% (25,000-10,000) = 6,000       9,000
12/31/05 40% (25,000-16,000) = 3,600       5,400
12/31/06                           400*    5,000=SV
12/31/07                            -0-    5,000
*formula will exceed salvage value limit in 2006; just
 depreciate $400, to salvage of $5,000.
                                                         30
      Exercise 9-15, continued
(a) JE to scrap after 3 years, at 12/31/05,
  assumes that no cash is received:
Accumulated depr.       19,600
Loss on disposal         5,400
     Equipment                   25,000




                                              31
      Exercise 9-15, continued
(b) JE to scrap after 5 years, assumes that no
  cash is received:
Accumulated depr.      20,000
Loss on disposal        5,000
     Equipment                  25,000




                                            32
       Exercise 9-15, continued
(c) JE to sell for $8,000 after 3 years:
Cash                     8,000
Accumulated depr.       19,600
     Gain on sale                  2,600
     Equipment                    25,000




                                           33
       Exercise 9-15, continued
(d) JE if, after 5 years, the equipment and
  $28,000 traded for a dissimilar asset with a
  fair market value of $30,000:
Asset (new)            30,000
Accumulated depr.      20,000
Loss on trade           3,000
     Equipment (old)             25,000
     Cash                        28,000




                                             34
          B. Intangible Assets
 Intangible assets 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.
 Intangibles include the following:
   (1) Patents
   (2) Copyrights
   (3) Trademarks
   (4) Organization Costs
   (5) Software Development Costs
   (6) Goodwill
                                                       35
         (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.
    – Most research and development costs for an
      internally developed patent.

                                                           36
 Class Exercise: Exercise 9-20, Part (a)
(1) $50,000 capitalized in 2005 (none amortized in the
  year of acquisition), so balance at 12/31/05?
       $50,000
(2)$200,000 incurred in 2006 to successfully defend
  patent. Amortization? Since defense is successful,
  add amount to cost of patent, and amortize:
      (50,000 + 200,000)/5 years = 50,000 per year
  Balance at end of 2006?
      250,000 - 50,000 = $200,000
(3) Journal entry at 12/31/2006 for amortization:
    Amortization expense          50,000
        Patent                             50,000
                                                     37
 Class Exercise: Exercise 9-20, Part (b)
(1) $50,000 capitalized in 2005 (none amortized in
  the year of acquisition), so balance 12/31/05:
  50,000
(2)$200,000 incurred in 2006 in unsuccessful
  defense of patent. Since unsuccessful,
  expense legal fees.
  Balance at end of 2006 - if patent no longer of
  value based on the court ruling: -0-
(3) Journal entry at 12/31/06 to write off patent:
    Loss on Patent        50,000
         Patent                       50,000
                                                     38
  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.

                                                   39
            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
     – include underwriting fees, legal and accounting,
       licenses, titles, etc.
     – treatment similar to research and development
       costs; even though there may be some future
       benefit, costs are expensed in the period incurred.   40
    Other Intangible Assets - continued
   (5) Software Development Costs
     – Capitalize the costs of developing software for sale
       or lease.
     – Expense software development costs if for internal
       use.
   (6) Goodwill (also discussed in Chapter 8)
     – The “unidentifiable” intangible
     – Causes include reputation, good customer relations,
       superior product development, etc.
     – Recognized when one company purchases another
       company.
     – To calculate:
        Purchase price paid for the company versus the
        fair market value of the net assets acquired
        = Goodwill (the excess amount paid)
                                                         41

				
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