Chapter 07 – Long-Term Assets
7-1
Chapter 7
Long-Term Assets
INSTRUCTOR’S MANUAL
Learning Objectives
LO7-1 Identify the major types of property, plant, and equipment.
LO7-2 Identify the major types of intangible assets.
LO7-3 Describe the accounting treatment of expenditures after acquisition.
LO7-4 Calculate depreciation of property, plant, and equipment.
LO7-5 Calculate amortization of intangible assets.
LO7-6 Account for the disposal of long-term assets.
Analysis
LO7-7 Describe the links among return on assets, profit margin, and asset turnover.
Appendix
LO7-8 Identify impairment situations and describe the two-step impairment process.
Chapter 07 – Long-Term Assets
7-2
Teaching Suggestions
Chapter 7 is separated into three parts. Part A focuses on acquisitions and improvements. What
amounts should we include in the cost of long-term assets? Part B addresses depreciation and
amortization. How do we expense the cost of long-term assets over the period benefited? Part C
describes the reporting of asset dispositions. How do we record the sale or disposal of a long-
term asset at the end of its useful life? Many financial accounting textbooks first cover all the
reporting issues for property, plant, and equipment and then repeat many of these issues again in
a discussion of the reporting of intangible assets. Since the basic principles in the reporting of
long-term assets are similar, we combine the reporting of property, plant, and equipment with the
reporting of intangible assets to avoid unnecessary repetition.
Part A begins with reporting the cost of property, plant and equipment. Separate discussions
are provided for land, land improvements, buildings, equipment, and natural resources.
Intangible assets including patents, copyrights, trademarks, franchises, and goodwill are covered
next. Part A finishes with a discussion of the accounting treatment of expenditures after
acquisition, including repairs and maintenance, additions, improvements, and litigation costs.
Illustration 7-7 provides a helpful summary of expenditures after acquisition.
Part B contrasts the dictionary definition of depreciation with the accounting definition. This
is important as many students mistakenly think of depreciation as a decrease in value. Straight-
line depreciation is explained in detail as this method is much more common in practice.
Illustrations using the same delivery truck example are also provided for declining-balance and
activity-based methods, providing instructors flexibility in choosing whether to just cover
straight-line depreciation or to demonstrate multiple depreciation methods. The sum-of-the-
years-digits depreciation method is not included since it is rarely used in practice. Part B
concludes by showing how amortization of intangible assets is similar to depreciation of tangible
assets.
Part C continues the delivery truck example to illustrate the recording of sale, retirement, and
an exchange of long-term assets. Note that a recent standard (FASB ASC 845: Nonmonetary
transactions) simplified the accounting for an exchange of long-term assets. Gains are usually not
deferred on exchanges of similar assets. The final section of the chapter uses actual financial
statement data for Walmart and Costco to analyze the profitability of a company’s assets. This is
done by separating return on assets into profit margin and asset turnover. We find that Walmart
has a higher profit margin, while Costco has a higher asset turnover.
The appendix describes the two-step impairment process. Including this topic in an appendix
provides instructors the choice of whether or not to cover asset impairments in the first
accounting class. Illustration 7-31 provides a nice overview of the two-step impairment process.
Students might also be interested in learning about the management practice of taking a “big
bath” discussed in the decision maker’s perspective at the end of the appendix.
Chapter 07 – Long-Term Assets
7-3
A
As
ss
si
ig
gn
nm
me
en
nt
t
C
Ch
ha
ar
rt
ts
s
Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO7-1
Describe how WorldCom carried out the largest
fraud in U.S. history
5
2
LO7-1
Explain how the two major categories of long-term
assets differ
5
3
LO7-1
Explain how we initially record a long-term asset
5
4
LO7-1
Discuss how incorrectly recording an expense as an
asset affects the financial statements
5
5
LO7-1
Identify costs incurred to make land ready for use
5
6
LO7-1
Explain why we record land and land improvements
separately
5
7
LO7-1
Identify costs incurred to make equipment ready for
use
5
8
LO7-1
Provide examples of natural resource assets
5
9
LO7-2
Explain how the accounting treatment differs
between purchased and internally developed
intangible assets
5
10
LO7-2
Describe the differences among a patent, a
copyright, and a trademark
5
11
LO7-2
Explain what is goodwill and how we measure it
5
12
LO7-3
Explain how we decide whether to capitalize or
expense a particular cost
5
13
LO7-3
Explain the usual accounting treatment for repairs
and maintenance, additions, and improvements
5
14
LO7-3
Discuss the reporting of litigation costs to defend an
intangible asset
5
15
LO7-4
Describe how the dictionary definition differs from
the accounting definition of depreciation
5
16
LO7-4
Identify factors that must be estimated in allocating
the cost of a long-term asset over its service life
5
17
LO7-4
Explain how we determine service life under
different depreciation methods
5
18
LO7-4
Define residual value and explain how it is used in
calculating depreciation under the straight-line
method
5
19
LO7-4
Contrast the effects of the straight-line, declining-
balance, and activity-based depreciation methods
5
20
LO7-4
Explain the difficulty of comparing companies that
use different depreciation methods
5
21
LO7-4
Explain the difficulty of comparing companies that
estimate different service lives for similar assets
5
Chapter 07 – Long-Term Assets
7-4
22
LO7-4
Identify the most common depreciation method for
financial reporting and tax reporting
5
23
LO7-5
Describe which intangible assets are subject to
amortization
5
24
LO7-6
Explain how we compute the gain or loss on the sale
of long-term assets
5
25
LO7-7
Describe return on assets, profit margin, and asset
turnover
5
26
LO7-7
Provide an example of a company with a high profit
margin and one with a high asset turnover
5
27
LO7-8
Describe the two-step process for recording
impairments
5
Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE7-1
LO7-1
Determine the initial cost of land
5
BE7-2
LO7-1
Determine the initial cost of equipment
5
BE7-3
LO7-2
Calculate goodwill
5
BE7-4
LO7-2
Compute research and development expense
5
BE7-5
LO7-3
Account for expenditures after acquisition
5
BE7-6
LO7-4
Explain the accounting definition of depreciation
5
BE7-7
LO7-4
Calculate partial-year depreciation
10
BE7-8
LO7-4
Calculate depreciation
10
BE7-9
LO7-5
Calculate amortization expense
10
BE7-10
LO7-6
Account for the sale of long-term assets
5
BE7-11
LO7-6
Account for the exchange of long-term assets
5
BE7-12
LO7-6
Account for the exchange of long-term assets
5
BE7-13
LO7-7
Use the return on assets ratio
5
BE7-14
LO7-8
Determine the impairment loss
5
BE7-15
LO7-8
Determine the impairment loss
5
Chapter 07 – Long-Term Assets
7-5
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E7-1
LO7-1
Record purchase of land
15
E7-2
LO7-1
Record purchase of equipment
15
E7-3
LO7-1
Allocate costs in a basket purchase
15
E7-4
LO7-1, 7-4
Ethical dilemma in a basket purchase
15
E7-5
LO7-2
Reporting intangible assets
15
E7-6
LO7-2
Calculate the amount of goodwill
15
E7-7
LO7-2
Record patent and research and development
expense
15
E7-8
LO7-2, 7-4
Match terms used in the chapter
10
E7-9
LO7-3
Record expenditures after acquisition
10
E7-10
LO7-4
Determine depreciation for the first year under three
methods
20
E7-11
LO7-4
Determine depreciation under three methods
35
E7-12
LO7-4
Determine straight-line depreciation for partial
periods
15
E7-13
LO7-4
Determine straight-line depreciation for partial
periods
15
E7-14
LO7-4
Determine depreciation expense for a change in
depreciation estimate
15
E7-15
LO7-4
Determine activity-based depreciation
10
E7-16
LO7-5
Record amortization expense
20
E7-17
LO7-6
Record the sale of equipment
15
E7-18
LO7-6
Record an exchange of land
10
E7-19
LO7-7
Calculate ratios
15
E7-20
LO7-8
Calculate impairment loss
15
E7-21
LO7-2, 7-4, 7-7
Complete the accounting cycle using long-term
asset transactions
60
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P7-1A
LO7-1
Determine the acquisition cost of land and building
30
P7-2A
LO7-1
Determine the acquisition cost of equipment
20
P7-3A
LO7-2
Calculate and record goodwill
25
P7-4A
LO7-3
Record expenditures after acquisition
20
P7-5A
LO7-4
Determine depreciation under three methods
45
P7-6A
LO7-5
Record amortization and prepare the intangible
assets section
30
P7-7A
LO7-4, 7-5
Compute depreciation, amortization, and book value
of long-term assets
30
P7-8A
LO7-6
Record the disposal of equipment
25
P7-9A
LO7-7
Calculate and interpret ratios
35
7-6
P7-10A
LO7-7
Calculate and interpret ratios
35
P7-1B
LO7-1
Determine the acquisition cost of land and building
30
P7-2B
LO7-1
Determine the acquisition cost of equipment
20
P7-3B
LO7-2
Calculate and record goodwill
25
P7-4B
LO7-3
Record expenditures after acquisition
20
P7-5B
LO7-4
Determine depreciation under three methods
45
P7-6B
LO7-5
Record amortization and prepare the intangible
assets section
30
P7-7B
LO7-4, 7-5
Compute depreciation, amortization, and book value
of long-term assets
30
P7-8B
LO7-6
Record the disposal of equipment
25
P7-9B
LO7-7
Calculate and interpret ratios
35
P7-10B
LO7-7
Calculate and interpret ratios
35
Additional
Perspectives
Topic
Time
(Min.)
AP7-1
Continuing Problem: Great Adventures
40
AP7-2
Financial Analysis: American Eagle Outfitters, Inc.
20
AP7-3
Financial Analysis: The Buckle, Inc.
20
AP7-4
Comparative Analysis: American Eagle Outfitters, Inc. and The
Buckle, Inc.
35
AP7-5
Ethics
20
AP7-6
Internet Research
20
AP7-7
Written Communication
20
AP7-8
Earnings Management
35
Chapter 07 – Long-Term Assets
7-7
Chapter Quiz Questions
The following multiple-choice questions are 10 unique quiz questions that correspond to the 10
questions at the end of each chapter. Each question covers the same learning objective but with a
little different twist. The correct answer is highlighted in bold for each item.
LO7-1
1. We initially record long-term assets at the:
a. Cost of the asset.
LO7-1
2. Tasty Inn and Out incurred the following costs related to its purchase of equipment.
$10,000
700
500
200
1,000
$12,400
What is the recorded cost of the equipment?
a. $10,000
LO7-2
3. An exclusive 20-year right to manufacture a product or to use a process is a:
d. Franchise.
LO7-3
4. Which of the following expenditures should be recorded as an expense?
a. An addition.
7-8
LO7-4
5. Which of the following will result in higher depreciation expense in the first year of the
asset’s life?
LO7-4
6. The asset’s cost less accumulated depreciation is called:
a. Replacement cost.
LO7-4
7. Depreciation in accounting is the:
a. Decrease in fair value of an asset.
LO7-5
8. Which of the following statements is false regarding the amortization of intangible assets?
LO7-6
9. Equipment originally costing $65,000 has accumulated depreciation of $25,000. If the
equipment is sold for $50,000, the company should record:
LO7-7
10. The return on assets is equal to:
a. Net income divided by long-term assets.
Chapter 07 – Long-Term Assets
7-9
Alternate Let’s Review
Chicago Style Pizza purchases a delivery van at a cost of $30,000. On the date of purchase, the
company estimates the van will have a residual value of $5,000. The company expects to use the
van for five years or about 100,000 miles.
Required:
Prepare a depreciation schedule using each of the following methods:
1. Straight-line.
2. Double-declining-balance.
3. Activity-based.
Actual use per year was as follows:
Year
Miles Used
1
22,000
2
24,000
3
18,000
4
21,000
5
20,000
Total
105,000
Solution:
1. Straight-line
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Depreciable
Cost
X
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
1
25,000
0.20
5,000
5,000
25,000
2
25,000
0.20
5,000
10,000
20,000
3
25,000
0.20
5,000
15,000
15,000
4
25,000
0.20
5,000
20,000
10,000
5
25,000
0.20
5,000
25,000
Chapter 07 – Long-Term Assets
7-10
2. Double-declining-balance
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Beginning
Book Value
X
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
1
30,000
0.40
12,000
12,000
18,000
2
18,000
0.40
7,200
19,200
10,800
3
10,800
0.40
23,520
4
0.40
25,000
5
0.40
25,000
3. Activity-based
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Miles
Used
X
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
1
22,000
$0.25
5,500
5,500
24,500
2
24,000
$0.25
6,000
11,500
18,500
3
18,000
$0.25
4,500
16,000
14,000
4
21,000
$0.25
5,250
21,250
5
20,000
$0.25
3,750***
25,000
25,000
Chapter 07 – Long-Term Assets
7-11
Key Points by Learning Objective
LO7-1 Identify the major types of property, plant, and equipment.
LO7-2 Identify the major types of intangible assets.
We record purchased intangibles as long-term assets at their purchase price plus all costs
LO7-3 Describe the accounting treatment of expenditures after acquisition.
LO7-4 Calculate depreciation of property, plant, and equipment.
Depreciation refers to the allocation of an asset’s original cost to an expense during the periods
benefited. Depreciation does not refer to the change in value or selling price.
LO7-5 Calculate amortization of intangible assets.
LO7-6 Account for the disposal of long-term assets.
Chapter 07 – Long-Term Assets
7-12
Analysis
LO7-7 Describe the links among return on assets, profit margin, and asset turnover.
Return on assets indicates the amount of net income generated for each dollar invested in assets.
Appendix
LO7-8 Identify impairment situations and describe the two-step impairment process.
Impairment is a two-step process. Step 1: Test for impairment: The long-term asset is impaired
Chapter 07 – Long-Term Assets
7-13
Common Mistakes
Common Mistake
Many students incorrectly add or ignore the cash received from the sale of salvaged materials.
Cash received from the sale of salvaged materials reduces the total cost of land.
Common Mistake
Students sometimes mistake accounting depreciation as recording the decrease in value of an
asset. Depreciation in accounting is not a valuation process. Rather, depreciation in accounting is
an allocation of the asset’s cost to expense over time.
Common Mistake
Some students want to depreciate land. Land is not depreciated because its service life never
ends.
Common Mistake
Many students think March 1 to the end of the year is nine months because December is the
twelfth month and March is the third month. March 1 to the end of the year is actually ten
months; it is every month except January and February.
Common Mistake
multiply cost times the depreciation rate. In the final year, some students incorrectly calculate
depreciation expense in the same manner as in earlier years, multiplying book value by the
depreciation rate. However, under the declining-balance method, depreciation expense in the
final year is the amount necessary to reduce book value down to residual value.
When using the declining-balance method, mistakes are commonly made in the first and last year
of the calculation. In the first year, students sometimes calculate depreciation incorrectly as cost
Common Mistake
Some students forget to update depreciation prior to recording the disposal of the asset.
Depreciation must be recorded up to the date of the sale, retirement, or exchange. Otherwise, the
book value will be overstated, and the resulting gain or loss on disposal will be in error as well.
Common Mistake
and accumulated depreciation from the accounting records separately. Otherwise, the Equipment
and the Accumulated Depreciation accounts will incorrectly have a remaining balance after the
asset has been sold.
Be careful not to combine the delivery truck ($40,000) and accumulated depreciation ($21,000)
and credit the $19,000 difference to the Equipment account. Instead, remove the delivery truck
Chapter 07 – Long-Term Assets
7-14
Common Mistake
we divide a number in the income statement by a number in the balance sheet, it’s more
Students sometimes divide by ending total assets rather than by average total assets. We measure
Common Mistake
Some students forget step 1 when considering impairment. Record an impairment loss only when
Chapter 07 – Long-Term Assets
7-15
Decision Points
Question
Accounting Information
Analysis
fair value?
opposite.
How different is the
asset’s recorded book
Gain or loss on sale
A gain on sale indicates the actual fair
value is more than the recorded book
Question
Accounting Information
Analysis
How effectively is the
company using its
assets?
Return on assets ratio
A higher return on assets generally
indicates a more effective use of
assets.
Question
Accounting Information
Analysis
sales?
income per dollar of sales.
How much profit is
Profit margin
A higher profit margin indicates a
Question
Accounting Information
Analysis
sales from its assets?
volume per dollar of assets invested.
Is the company
Asset turnover ratio
A higher asset turnover indicates a
Chapter 07 – Long-Term Assets
7-16
Career Corner
Career Corner
The legal defense of intangible asset rights often requires the services of a lawyer. Accounting
and law actually have a lot in common. Some business professionals (such as those specializing
in tax law) have both a CPA license and a law degree. If you are considering a career in law,
Chapter 07 – Long-Term Assets
7-17
Ethical Dilemma
Ethical Dilemma
James Wright is the chief financial officer (CFO) for The Butcher Block, a major steakhouse
restaurant chain. As CFO, James has the final responsibility for all aspects of financial reporting.
James tells investors that The Butcher Block should post earnings of at least $1 million.
In examining the preliminary year-end numbers, James notices that earnings are coming in at