Chapter 10
Long-Term Assets
Learning Objectives
1. Identify the classications of long-term assets, and describe how they are valued by
allocating their cost to the periods that they benet.
2. Account for the acquisition cost of property, plant, and equipment.
3. Compute depreciation under the straight-line, production, and declining-balance
methods.
4. Account for the disposal of depreciable assets.
5. Identify the issues related to accounting for natural resources and compute depletion.
6. Identify the issues related to accounting for intangible assets, including research and
development costs and goodwill
7. Describe the disclosure of acquiring and nancing long-term assets, and calculate free
cash )ow.
Section 1: Concepts
Concepts
Valuation
Classication
Accrual Accounting (matching rule)
Disclosure
Recognition
Lecture Outline
0. Long-term assets have three characteristics in common:
0. They have a useful life of more than one year.
0. They are used in the operation of a business.
0. They are not intended for resale to customers.
0. Tangible assets consist of property, plant, equipment, and natural resources.
0. Intangible assets consist of patents, copyrights, goodwill, and the like.
0. The major accounting issue is the allocation of cost (as expenses) to accounting
periods.
0. Property (not land, however), plant, and equipment are subject to depreciation.
0. Natural resources are subject to depletion.
0. Intangible assets are subject to amortization.
0. Carrying value (book value) equals cost less accumulated depreciation.
I0. All long-term assets are subject to an asset impairment evaluation.
VII. An expenditure (a payment or incurrence of a liability) is one of two types.
0. A capital expenditure benets more than one period and is recorded as an asset.
0. A revenue expenditure benets only the current period and is expensed.
VIII0. Additions and betterments (improvements) are capital expenditures and are debited
to an asset account.
I0. Extraordinary repairs increase an asset’s residual value or useful life. These capital
expenditures are debited to accumulated depreciation.
X0. Errors in properly classifying expenditures result in misstatements in assets and net
income of the current and future periods.
Summary
Long-term assets (also called xed assets) are assets that (1) have a useful life of more
than one year, (2) are acquired for use in the operation of a business, and (3) are not
intended for resale to customers. Property, plant, and equipment is the balance sheet
classication representing tangible assets, such as land, buildings, equipment, and
natural resources. Intangible assets is the balance sheet classication representing
intangible assets, such as patents, trademarks, goodwill, copyrights, leaseholds, leasehold
improvements, and franchises.
In dealing with long-term assets, the major accounting issue is to determine how much of
the asset has beneted the current period and how much should be carried forward as an
asset to benet future periods. This allocation of costs to di9erent accounting periods is
called depreciation in the case of plant and equipment (plant assets), depletion in the
case of natural resources, and amortization in the case of intangible assets. Because land
normally has an unlimited useful life, its cost is not converted into an expense. The
unexpired cost of an asset is called the carrying value, or book value, and is equal to the
cost less accumulated depreciation. Asset impairment is the loss of the
revenue-generating potential of a long-lived asset before the end of its useful life. It is
computed as the di9erence between the asset’s carrying value and its fair value. If market
prices are not readily available, this may be measured by the present value of the expected
cash )ows resulting from the use of the asset.
An expenditure (a payment or obligation to make a future payment for an asset or a
service) is one of two types. A capital expenditure, such as the purchase or expansion of a
building, benets several accounting periods and is recorded as an asset. A revenue
expenditure, such as an operation and maintenance cost, benets only the current period
and is expensed.
In addition to expenditures to purchase plant and equipment, capital expenditures include
additions (such as a building wing) and betterments (such as installation of an
air-conditioning system). Such a capital expenditure is recorded as an asset because it
benets several accounting periods.
Ordinary repairs are expenditures necessary to maintain an asset in good operating
condition so that the asset may attain its originally intended useful life; they are charged as
an expense in the period incurred. Extraordinary repairs are expenditures that either
increase an asset’s residual value or lengthen its useful life—a major overhaul, for example.
They are recorded by debiting Accumulated Depreciation and crediting Cash or Accounts
Payable.
If a capital expenditure is recorded mistakenly as a revenue expenditure, current period
expense is overstated and net income is understated. In future periods, net income will be
overstated, since the capital expenditure was all expensed in the rst period. The opposite
e9ects would be true for a revenue expenditure recorded mistakenly as a capital
expenditure.
Relevant Examples and Exhibits
Exhibit 1 Long-Term Assets as a Percentage of Total Assets for Selected Industries
Exhibit 2 Classication of Long-Term Assets and Methods of Accounting for Them
Exhibit 3 Carrying Value of Long-Term Assets on the Balance Sheet
Teaching Strategy
Students are likely accustomed to using the following key terms in a more general sense, so
it is helpful to emphasize their specic application to the context of this subject:
Tangible assets
Intangible assets
Natural resources
Amortization
Depreciation
Depletion
Dene capital expenditures, paying particular attention to how they are distinguishable from
revenue expenditures. Review the concept of materiality and the matching rule.
Section 2: Accounting Applications
Accounting Applications
Computing acquisition cost
Computing depreciation
oStraight-line method
oProduction method
oDeclining-balance method
Accounting for the disposition of depreciable assets
Accounting for natural resources
Accounting for intangible assets
Lecture Outline
I0. The cost of a long-term asset includes the purchase cost, freight, installation, insurance
while in transit, and any other costs required to ready the asset for operation.
0. The cost of land includes real estate commissions, lawyers’ fees, accrued taxes
paid by the buyer, razing a building, draining, clearing, grading, assessments, and
landscaping.
0. Land improvements include driveways, parking lots, fences, and signs.
0. The cost of buildings purchased includes the purchase price and repairs to make
the building usable.
0. The cost of an asset constructed includes materials, labor, overhead, architects’
and lawyers’ fees, insurance during construction, and interest on a construction
loan.
E. Leasehold improvements are depreciated over the remaining term of the lease or
the useful life of the improvement, whichever is shorter.
F0. The cost of equipment includes the invoice price less cash discounts, freight,
insurance, taxes, tari9s, buying expenses, installation costs, and test runs.
G0. Interest on a loan to purchase an asset is expensed. Interest on a construction loan
is capitalized.
H0. All plant assets except land (i.e., land improvements, buildings, equipment) are
depreciated
I. When a group purchase is made, the lump-sum cost is apportioned among the
assets based on their relative fair market values.
0II0. Depreciation is the logical allocation of asset cost to the periods that benet from the
services of that asset.
A0. Depreciable assets have limited useful lives because of physical deterioration and
obsolescence.
0 B. Several factors a9ect the computation of depreciation.
10. Cost
20. Residual (salvage) value
30. Depreciable cost
40. Estimated useful life (in time or in units)
C0. The three most common methods of depreciation.
10. The straight-line method (based on the passage of time)
a0. The formula for the straight-line method:
Cost – Residual Value
Estimated Useful Life (in accounting periods)
20. The production method (based on units produced, miles driven, and the like)
a0. The formula for the production method:
Cost – Residual Value
Estimated Units of Useful
Life
b. The production method is a good application of the matching principle,
but it can be used only if output over useful life can be estimated with
reasonable accuracy.
30. The declining-balance method (an accelerated method)
a0. The double-declining-balance formula:
Remaining Carrying Value × 100% × 2
Useful Life (in
years)
b. Residual value is ignored initially, but an asset may not be depreciated
below its residual value.
D0. Compare the three depreciation methods by referring to Figure 7 in the text.
III0. Special issues in determining depreciation
A. Group depreciation saves time by depreciating a group of similar assets as a
whole.
B. When an asset is owned for less than a year, only a partial year’s depreciation
should be taken.
1. Under the half-year convention, one-half year’s depreciation is recorded in the
year of purchase and one-half year’s depreciation is recorded in the year of
disposition.
C0. After an asset has been put into use, its estimated useful life or residual value may
be revised.
10. Leave the previously taken depreciation unchanged.
20. Revise the useful life or residual value.
30. Allocate the remaining depreciable cost over the remaining useful life.
D0. Accelerated cost recovery allows companies to take rapid write-o9s of plant assets
for tax purposes. This method is usually not acceptable for nancial reporting
purposes.
IV0. An asset is disposed of when it is discarded, sold, or traded in.
A0. Record depreciation for the period preceding disposal.
B0. Journalize the disposal of an asset.
10. Debit Accumulated Depreciation and credit the asset account.
20. Debit any receipt of cash.
30. Debit or credit a loss or gain on disposal if cash received di9ers from the
carrying value.
40. Credit asset for recorded cost.
C0. Account for the exchange of similar assets.
10. For nancial accounting purposes, losses are recognized, but gains are not.
20. For tax purposes, neither gains nor losses are recognized.
D0. Account for the exchange of dissimilar assets.
10. Gains and losses are recognized for both reporting and tax purposes.
V0. Depletion is recognized for natural resources.
A. Depletion is the allocation of the cost of a natural resource over the periods
beneted.
B0. The formula for depletion cost per unit:
Cost – Residual Value
Estimated Number of Units
C0. Units extracted but not sold are recorded as inventory.
D0. Tangible assets used with natural resources should be depreciated over the shorter
of the life of the tangible asset or the life of the natural resource.
VI0. There are two methods of accounting for oil and gas development and exploration
costs.
0. Under successful e9orts accounting, only the cost of productive wells is
capitalized.
0. Under the full-costing method, the cost of all wells is capitalized.
VI0. Intangible assets represent rights and privileges extended to their owner.
A0. Other than goodwill, intangible assets usually are capitalized and expensed over
their useful lives (not to exceed 40 years) in accordance with the matching rule.
B0. Research and development costs are expensed.
C0. Computer software costs are expensed until a product has been proved to be
technologically feasible, then they are capitalized.
D0. Goodwill is the excess of the purchase cost over the fair market value of the net
assets purchased.
10. Goodwill usually is estimated based on superior past earnings.
20. For nancial reporting purposes, goodwill is an asset to be reported as a
separate line item on the balance sheet and is subject to an annual
impairment review.
E. The purchase, use, and disposal of long-term assets a9ect all nancial statements.