Chapter 08 – Reporting and Analyzing Long-Term Assets
Chapter Outline
Notes
VI. Section 3 — Intangible Assets—nonphysical assets (used in
operations) that confer on their owners long-term rights, privileges, or
competitive advantages.
A. Cost Determination and Amortization
1. An intangible asset is recorded at cost when purchased.
Intangibles are then separated into those with limited lives or
indefinite lives. For those with a limited life, its cost is
systematically allocated to expense over its estimated useful
life through a process called amortization. If an intangible
asset has an indefinite life, it should not be amortized.
2. Amortization is similar to depreciation and depletion, except
that only the straight-line method is generally used for
amortization.
3. The effects of amortization are recorded in a contra account
called Accumulated Amortization. The gross acquisition cost
and accumulated amortization are disclosed in the balance
sheet.
B. Types of Intangibles
1. Patents—an exclusive right granted to its owner to
manufacture and sell a patented machine or device, or to use
a process, for 20 years.
2. Copyrights—the exclusive right given to its owner to publish
and sell a musical, literary, or artistic work during the life of
the creator plus 70 years.
3. Franchises and Licenses—rights that a company or
government grants an entity to deliver a product or service
under specified conditions. If for an indefinite period, costs
are not amortized.
4. Trademarks and Trade Names—symbols, names, phrases,
or jingles identified with a company, product, or service. If
the company plans to renew indefinitely its right to the
trademark, the cost is not amortized.
5. Goodwill—meaning in accounting: the amount by which the
value of a company exceeds the value of its individual assets
and liabilities; implies the company as a whole has certain
value attributes not measured among its individual assets and
liabilities.
6. Leaseholds—lessee is granted the right to use property by the
lessor, the property’s owner.
7. Leasehold improvements—alterations or improvements to
leased property, such as partitions, painting, and storefronts.
8. Other Intangibles-include assets such as software,
noncompete convenants, customer lists, etc. Record the
intangible asset’s costs, then determine whether the asset has
a limited or indefinite life. If limited, allocate its costs over
that period. If indefinite, its costs are not amortized.
Chapter 08 – Reporting and Analyzing Long-Term Assets
8-9
Chapter Outline
Notes
VII. Global View
A. Accounting for Plant Assets – Cost, depreciation, additional
expenditures and disposals of plant assets are treated similarly
under both GAAP and IFRS. The one area where there are
differences is in accounting for changes in the value of plant
assets. IFRS requires an annual review of useful life and salvage
value estimates.
1. Decreases in the Value of Plant Assets – When the value of plant
assets declines after acquisition, but before disposition, both
GAAP and IFRS require companies to record those decreases
as impairment losses. GAAP revalues impaired plant assets to
fair value whereas IFRS revalues them to a recoverable amount.
2. Increases in the Value of Plant Assets – GAAP prohibits
companies to record increases in the value of plant assets.
IFRS permits upward asset revaluations. If an impairment was
previously recorded, a company would reverse that impairment
to the extent necessary and record that increase in income. If
the increase is beyond the original cost, that increase is
recorded in comprehensive income.
B. Accounting for Intangible Assets – GAAP and IFRS are broadly
similar in terms of cost determination, depreciation, additional
expenditures and disposals of intangible assets, however these two
systems handle decreases and increases in the value of intangible
assets differently. IFRS requirements for recording increases in
the value of intangible assets are so restrictive that such increases
are rate.
VIII. Decision Analysis—Total Asset Turnover
A. Total asset turnover is a measure of a company’s ability to use
its assets most efficiently and effectively.
B. Calculated by dividing net sales by average total assets.
C. It is safe to say that all companies desire a high total asset
turnover. However, interpreting a company’s total asset
turnover requires an understanding of the company’s
operations.
1. Some operations are capital intensive, meaning that a
relatively large amount is invested in assets to generate sales,
which would suggest a lower total asset turnover.
2. Other operations are labor intensive, meaning that they
generate sales more by the efforts of people than the use of
assets; a higher total asset turnover would be expected.
Chapter Outline
Notes
IX. Exchanging Plant Assets (Appendix 8A) Many plant assets are
disposed of by exchanging them for newer assets. In a typical
Chapter 08 – Reporting and Analyzing Long-Term Assets
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exchange, a trade-in allowance is received on the old asset and the
balance is paid in cash. Accounting for the exchange depends on
whether the transaction has commercial substance. An exchange has
commercial substance if the company’s future cash flows change as a
result of the transaction. If an asset exchange has commercial
substance, a gain or loss is recorded based on the difference between
the book value of the asset given up and the market value of the asset
received. If an asset exchange lacks commercial substance, no gain or
loss is recorded, and the asset received is recorded based on book
value of the asset given up.
A. Exchange with Commercial Substance: A Loss
When the book value of the assets given up (cash paid plus book
value of the old equipment) is more than the market value of the
equipment received, a loss is recorded. Entry: debit the new
equipment for market value, debit Loss on Exchange of Assets
(difference between the book value of the assets given up and the
market value of the new asset), debit Accumulated Depreciation
for the old equipment, credit Equipment (old) for cost of the old
equipment, credit cash for the cash paid.
B. Exchange with Commercial Substance: A Gain
When the market value of the equipment received is more than
the book value of the assets given up (cash paid plus book value
of the old equipment), a gain is recorded. Entry: debit the new
equipment for market value, debit Accumulated Depreciation for
the old equipment, credit Equipment (old) for cost of the old
equipment, credit cash for the cash paid, and credit Gain on
Exchange of Assets for the gain (difference between market value
of the new asset and the book value of the assets given up).
C. Exchange without Commercial Substance
If the transaction lacks commercial substance, any gain or loss
which would have been recorded when the transaction had
commercial substance is not recorded. The unrecognized gain is
subtracted from the new asset’s market value to determine its cost
basis. The cost basis of the new asset also can be computed by
summing the book values of the assets given up.
Chapter 08 – Reporting and Analyzing Long-Term Assets
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VISUAL #8-1
FORMULAS FOR DEPRECIATION METHODS
1. STRAIGHT LINE
Cost – Estimated salvage Annual
Estimated useful life Depreciation
2. UNITS OF PRODUCTION
(Depreciable)
a) Cost – Estimated salvage Cost per
Predicted units of production Unit
b) CPU x units produced Depreciation
in period for PERIOD
(In last year, depreciate to estimated salvage value; never
depreciate below this amount.)
3. DOUBLE-DECLINING BALANCE
Book Value (beginning of year) x RATE* = Depreciation (for that year)
*RATE → The rate used is constant and it is twice what the
straight line rate would have been for this asset.
(In the last year, depreciate to estimated salvage value; never
depreciate below this amount.)
=
=
=
Chapter 08 – Reporting and Analyzing Long-Term Assets
8-12
Chapter 8 – Alternate Demonstration Problem #1
The New Times Company purchased a new machine on January 1, 2011.
The new machine cost $120,000, had an estimated useful life of five
years, and an estimated salvage value of $15,000 at the end of its useful
life. It was expected that the machine would produce 210,000 widgets
during its useful life.
The company used the machine for exactly three years. During these
three years, the annual production of widgets was 80,000, 50,000, and
30,000 units, respectively.
On January 1, 2015, the machine is sold for $45,000.
Required:
1. Calculate the depreciation expense for each of the first three years
using:
a. Straight-line
b. Units–of-production
c. Double-declining-balance
2. Prepare the proper journal entry for the sale of the machine under
each of the three different depreciation methods.
Chapter 08 – Reporting and Analyzing Long-Term Assets
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Solution: Chapter 8 – Alternate Demonstration Problem #1
1a. Straight-line:
The depreciation expense each year is equal to cost minus salvage
value divided by useful life. In this example the cost is $120,000,
the salvage value is $15,000, and the useful life is 5 years.
Therefore, the annual depreciation expense would equal:
(120,000 – 15,000) ÷ 5 = $21,000 per year
1b. Units–of-production:
The depreciation expense each year is equal to a rate [(cost minus
salvage) divided by total production] multiplied by the actual
number of units produced that year. In this example, the rate would
be $0.50 per widget, (120,000 ÷ 15,000) ÷ 210,000, and the
depreciation expense for each of the first three years would be:
Year 1
.50
x
80,000
=
40,000
Year 2
.50
x
50,000
=
25,000
Year 3
.50
x
30,000
=
15,000
1c. Double-declining balance:
The depreciation expense each year is equal to a rate (twice the
straight-line rate divided by useful life) multiplied by the asset’s net
book value (cost minus accumulated depreciation) at the beginning
of the year. In this example the rate would be 2/5, or 40%, and the
depreciation expense for each of the first three years would be:
Year 1
=
.40
x
120,000 (x)
=
48,000
Year 2
=
.40
x
72,000 (1)
=
28,800
Year 3
=
.40
x
43,200 (2)
=
17,280
Book value at beginning of year:
(1) 120,000 – 48,000 = 72,000
(2) 120,000 – 48,000 – 28,800 = 43,200
Chapter 08 – Reporting and Analyzing Long-Term Assets
8-14
Solution: Chapter 8 – Alternate Demonstration Problem #1, continued
2. The journal entry for the sale of the asset will have the same general
form regardless of the method of depreciation adopted, except that
whether there is a gain or a loss on the sale may change according to
the depreciation method used. The gain or loss on disposal of the
asset is determined by comparing the sale price, in this case $45,000,
with the net book value of the asset at the time of the sale.
Straight-line:
Cash ……………………………………
45,000
Accumulated depreciation …..
63,000
Loss on sale of machine ………
12,000
Machine …………………………
120,000
Units–of-production:
Cash ……………………………………
45,000
Accumulated depreciation
(40,000 + 25,000 + 15,000) ……
80,000
Machine …………………………
120,000
Gain on sale of machine …
5,000
Double-declining balance:
Cash ……………………………………
45,000
Accumulated depreciation
(48,000 + 28,800 + 17,280) ……
94,080
Machine …………………………
120,000
Gain on sale of machine …
19,080