Chapter 6 Long-lived Assets and Cost Allocation by zkd14107

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									Chapter 6: Long-lived Assets
and Cost Allocation
A. Property, Plant and Equipment
  – Depreciation
B. Natural Resources (Omit)
C. Intangible Assets
  – Amortization




                                   1
 A. Overview of Accounting for
 Property, Plant and Equipment

   Acquisition         Use            Disposal



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



                                                 2
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).
                                                  3
1. Acquisition:
   What Costs to Capitalize?
   Lump sum purchase price - allocate
    cost to various assets based on relative
    appraised value (or relative fair market
    value).
   Must separate costs because many
    assets have different depreciable lives,
    and some (land) are not depreciated.
       Now work Ex. 6-36.

                                               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.
    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.                                5
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.
    Now work Ex. 6-29.
                                                  6
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)
   Depreciation methods
    –   (1) Activity (units-of-production)
    –   (2) Straight-line
    –   (3) Double-declining balance
    –   (4) Sum-of-the-years digits
    –   (5) MACRS (omit)
                                                            7
Class Example
Given the following information regarding
 an automobile purchased by the
 company on January 2, 2000:
     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.

                                            8
(1) Units-of-production (Activity)
Assume that the car was driven 20,000 miles in
  the year 2000, and 30,000 miles in 2001.
Annual depreciation =
 Cost - Salvage Value       x Current Activity
 Total expected activity

For 2000= 10,000 - 2,000 x 20,000 = $1,600
          100,000 miles

For 2001 = 10,000 - 2,000 x 30,000 = $2,400
           100,000 miles

                                             9
(2) Straight-Line
Annual depreciation =
  Cost - Salvage
   Estimated Life
= 10,000 - 2,000 = $2,000 per year
        4 years




                                     10
(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:
   2000 = 50% x (10,000 - 0) = $5,000
   2001 = 50% x(10,000-5,000) = $2,500
                                               11
(4) Sum-of-the-years Digits
SYD is another accelerated technique that
  calculates more expense in early years and
  less in later years.
  Annual depr.= 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 2000 =4/10(10,000-2,000) = $3,200
D.E. for 2001 = 3/10(10,000-2,000) = $2,400

                                                12
(5) MACRS
MACRS - stands for “Modified Accelerated
   Cost Recovery System.”
It is used specifically by the IRS for tax
   depreciation, and is based upon the DDB,
   150% DB, and straight line methods.
It assumes zero salvage value, and 1/2 year
   depreciation in the first and last year.
A company must use the IRS designated
   useful life and method for a particular
   asset.
This will not be tested.


                                          13
3. Postacquisition Expenditures:
   Capitalize or Expense?
    Capital Expenditures:
     – Increase asset’s useful life
     – Improve quality of asset’s output
     – Increase quantity of asset’s output
     – Reduce asset’s operating costs
    Revenue Expenditures:
     – maintain existing productivity or useful life
    Accounting treatment
     – Capital expenditures are capitalized as
       asset.
     – Revenue expenditures are expensed.
                                                       14
4. Disposal: Retirement or Sale
   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 (omit)



                                                     15
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
       Now work Ex. 6-24.                       16
C. 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) using the straight line method with
    no salvage value.
   Intangibles include the following:
     – Patents, Copyrights, Trademarks,
        Franchise Costs, and Goodwill.




                                                    17
(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.
           Now work Ex. 6-41.
                                                 18
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.
                                                  19
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 20 year periods, but indefinite
       renewals.
     – some of design costs may be capitalized.




                                                       20
Other Intangible Assets - continued
   (5) Franchise Costs - payment to acquire franchise
    rights capitalized and amortized over life of
    contract.
   (6) Goodwill
     – 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
        Less the fair market value of the net assets
          acquired
        = Goodwill (the excess amount paid)
        (Note: goodwill is not amortized, but evaluated
          and written down if necessary.)             21
Goodwill Example
 Given the following information
  regarding Company S (in thousands):
                     Book         Fair Market
                     Value            Value
 Inventory         $     80          $ 100
 Equipment             900            1,000
 Notes Payable        (180)            ( 200)
 Net Assets          $ 800           $ 900
(Net assets = assets - liabilities)
                                           22
Assume Company P acquires Company S
for $1,000,000 cash.
Calculate the goodwill to be recognized:
 Purchase price                     $1,000,000
  FMV of net assets                    900,000
  Goodwill                          $ 100,000
Prepare the journal entry on the books of
  Company P to record the purchase:
  Goodwill              100,000
  Inventory             100,000
  Equipment           1,000,000
     Notes payable                200,000
     Cash                       1,000,000
           Now work Ex. 6-42.
                                                 23
 Ex. 6-29
a. Land and old building.
   All to land (see part c)
b. Legal fees for title.
   Land
c. Demolishing old building.
   Land
d. Surveying costs.
   Land
e. Construction of building.
   Building
 Ex. 6-29
f. Salary to construction supervisor.
   Building
g. Fencing of property.
   Land improvements
h. Machinery for plant.
   Machinery
i. Installation of machinery.
   Machinery
j. Landscaping.
   Land improvements (unless landscaping
   permanent (like trees), then use Land).
 Ex. 6-29
k. Office equipment.
   Equipment
l. Payment to architect.
   Building
m.Finishing work to offices.
   Building
n. Proceeds from sale of scrap from old bldg.
   Land (reduce cost)
Ex. 6-36
Total cost of $250,000 + 10,000 = $260,000
Total fair value=100,000+185,000+40,000=$325,000
Asset Fair value / Total FV x Total Cost = Cost
Bldg.     100,000 / 325,000 x 260,000 = $ 80,000
Equip. 185,000 / 325,000 x 260,000 = 148,000
Land        40,000 / 325,000 x 260,000 = 32,000
Total     325,000                        $260,000
Journal entry:    Building         80,000
                  Equipment       148,000
                  Land             32,000
                        Cash               10,000
                        Mort. Payable     250,000
Ex. 6-24
 Cost = 15,000, A/D = 12,000
 a. Sold for $5,000:
   Cash                 5,000
   A/D                 12,000
       Equipment                15,000
       Gain on Sale              2,000

 b. Sold for $2,000
   Cash                2,000
   A/D                12,000
    Loss on Sale       1,000
       Equipment                15,000
Ex. 6-24
 Cost = 15,000, A/D = 12,000
 c. Proceeds of $1,500 from insurance:
    Cash                 1,500
    A/D                 12,000
    Loss from Fire       1,500
       Equipment                   15,000
Ex. 6-24
 Cost = 15,000, A/D = 12,000

 d. Abandoned (no cash)
   A/D                 12,000
    Loss on Retirement 3,000
       Equipment                15,000
Ex. 6-41
Cost to purchase = $56,000
Legal costs = $4,000
Total cost = $60,000
Estimated life = 10 years (legal life irrelevant here)

Amortization for 19X1:
     60,000/10 = $6,000
Journal entry:
  Amortization Expense         6,000
     Patent                            6,000
Ex. 6-42
Journal entry (record FMV of identifiable assets,
  then calculate Goodwill)
Goodwill          76,000
Inventory         50,000
Equipment         18,000
Building          68,000
Land              45,000
     Accounts Payable          7,000
     Cash                   250,000
 Ex. 6-42
Calculation of GW:
GW = Cost                                  $250,000
      - FMV of Identifiable Net Assets =   -174,000*
                                           = 76,000 GW
*(50   + 18 + 68 + 45 - 7)

								
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