Chapter 07 – Long-Term Assets
7-1
Chapter 7
Long-Term Assets
INSTRUCTOR’S MANUAL
Authors’ Perspectives
Since the basic principles in the reporting of long-term assets are similar, we combine the
PART A: Acquisitions
LO7-1 Identify the major types of property, plant, and equipment.
Capitalized Cost – The underlying principle for recording long-term assets is to capitalize cost
equal to the asset’s purchase cost plus all expenditures necessary to get the asset ready for use.
We demonstrate this for property, plant and equipment (land, land improvements, buildings,
equipment, and natural resources) and for intangible assets (patents, copyrights, trademarks,
franchises, and goodwill).
• Illustrations 7-2 and 7-3 are examples that make it easy for students to see the full
capitalized cost.
When covering intangible assets, an interesting question to pose to students is whether
Goodwill is often the largest intangible asset reported by a company (and it’s the most
unique). Students find it interesting that most business acquisitions involve a company paying
more than the fair value of the target’s identifiable net assets. Ask them two questions:
1. Why would a company pay more than fair value?
Chapter 07 – Long-Term Assets
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Is the assumption to record goodwill as an intangible asset correct? Subsequent impairment
testing will ultimately let us know whether the payment represented (1) the purchase of valuable
resources or (2) overpayment to acquire another company.
PART B: Cost Allocation
LO7-4 Calculate depreciation of property, plant, and equipment.
LO7-5 Calculate amortization of intangible assets.
Depreciation – Part B starts with the dictionary definition of depreciation versus the accounting
definition. This is good place to start because many students think of depreciation as a decrease
in value. Accounting depreciation is not a measure of decline in value, and book value is not a
Flexibility in Coverage – This part of the chapter is structured to give instructors flexibility in
choosing whether to cover only straight-line depreciation or to cover multiple depreciation
methods. Straight-line depreciation is explained in detail as this method is much more common
in practice.
• Illustrations 7-11 (with video), 7-13 (with video), and 7-15 (with video) use the same
delivery truck example for straight-line, double-declining-balance, and activity-based
PART C: Asset Disposition: Sale, Retirement, or Exchange
LO7-6 Account for the disposal of long-term assets.
Chapter 07 – Long-Term Assets
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Disposition – Part C continues the delivery truck example to illustrate recording a sale of long-
term assets. It’s tempting for students to think of a “gain” and “loss” on the sale of a depreciable
Exchange – For recording an exchange, students should think about these four steps:
1. Record the new asset at fair value (debit new asset)
2. Remove the book value of the nonmonetary asset given up (debit accumulated depreciation
and credit old asset)
ANALYSIS
LO7-7 Describe the links among return on assets, profit margin, and asset turnover.
Asset Analysis – 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
APPENDIX: Asset Impairment
LO7-8 Identify impairment situations and describe the two-step impairment process.
Impairment – The appendix describes the two-step impairment process. Including this topic in
Chapter 07 – Long-Term Assets
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Self-Study Materials
■ Let’s Review—Expenditures after acquisition (p. 353).
■ Let’s Review—Depreciation methods (p. 362).
Chapter 07 – Long-Term Assets
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Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
students should be understanding. These Key Points are summarized by Learning Objective at
the end of the chapter, providing students with a convenient study guide.
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.
We capitalize (record as an asset) expenditures that benefit future periods. We expense items that
benefit only the current period.
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
LO7-5 Calculate amortization of intangible assets.
Amortization is a process, similar to depreciation, in which we allocate the cost of intangible
LO7-6 Account for the disposal of long-term assets.
If we dispose of an asset for more than book value, we record a gain. If we dispose of an asset
Chapter 07 – Long-Term Assets
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Analysis
LO7-7 Describe the links among return on assets, profit margin, and asset turnover.
and asset turnover.
Appendix
LO7-8 Identify impairment situations and describe the two-step impairment process.
Impairment is a two-step process. Step 1: Test for impairment: A long-term asset with a finite
Chapter 07 – Long-Term Assets
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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
Identify costs incurred to make equipment ready for
5
use
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
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
LO7-4
Define residual value and explain how it is used in
calculating depreciation under the straight-line
method
5
LO7-4
Contrast the effects of the straight-line, declining-
balance, and activity-based depreciation methods
5
LO7-4
Explain the difficulty of comparing companies that
use different depreciation methods
5
estimate different service lives for similar assets
Chapter 07 – Long-Term Assets
7-8
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
LO7-1
Allocate cost in a basket purchase
5
BE7-4
LO7-2
Calculate goodwill
5
BE7-5
LO7-2
Compute research and development expense
5
BE7-6
LO7-3
Account for expenditures after acquisition
5
BE7-7
LO7-3
Legal defense of intangible asset
5
BE7-8
LO7-4
Explain the accounting definition of depreciation
5
BE7-8
LO7-4
Calculate partial-year depreciation
10
BE7-10
LO7-4
Calculate depreciation
10
BE7-11
LO7-4
Change in depreciation estimate
10
BE7-12
LO7-5
Calculate amortization expense
10
BE7-13
LO7-6
Account for the sale of long-term assets
5
BE7-14
LO7-6
Account for the sale of long-term assets
5
BE7-15
LO7-6
Account for the retirement of long-term assets
5
BE7-16
LO7-6
Account for the exchange of long-term assets
5
BE7-17
LO7-6
Account for the exchange of long-term assets
5
BE7-18
LO7-7
Use the return on assets ratio
5
BE7-19
LO7-8
Determine the impairment loss
5
LO7-8
Determine the impairment loss
5
Chapter 07 – Long-Term Assets
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
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
LO7-2
Record patent and research and development
expense
15
E7-8
Match terms used in the chapter
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
LO7-4
Determine activity-based depreciation
10
LO7-5
Record amortization expense
20
LO7-6
Record the sale of equipment
15
LO7-6
Record an exchange of land
10
LO7-7
Calculate ratios
15
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
30
assets section
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
Chapter 07 – Long-Term Assets
7-10
LO7-1
Determine the acquisition cost of land and building
30
P7-2B
LO7-1
Determine the acquisition cost of equipment
20
LO7-2
Calculate and record goodwill
25
LO7-3
Record expenditures after acquisition
20
LO7-4
Determine depreciation under three methods
45
P7-6B
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
Comparative Analysis: American Eagle Outfitters, Inc. and The
Buckle, Inc.
AP7-5
Ethics
20
AP7-6
Internet Research
20
AP7-7
Written Communication
20
AP7-8
Earnings Management
35
Chapter 07 – Long-Term Assets
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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.
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
Solution:
1. Straight-line
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Depreciable
Cost
×
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
20,000
3
25,000
0.20
5,000
15,000
4
25,000
0.20
5,000
10,000
5
25,000
0.20
5,000
Chapter 07 – Long-Term Assets
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2. Double-declining-balance
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Beginning
Book Value
×
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
Total
25,000
*** Amount needed to reduce book value to residual value
3. Activity-based
Chicago Style Pizza
Calculation
End of Year Amounts
Year
Miles
Used
×
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
1
22,000
$0.25
5,500
5,500
24,500
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
Total
105,000
25,000
*** Amount needed to reduce book value to residual value
Chapter 07 – Long-Term Assets
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Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, student can avoid making the same mistakes and gain a deeper
understanding of the chapter material.
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
asset. Depreciation in accounting is not a valuation process. Rather, depreciation in accounting is
Students sometimes mistake accounting depreciation as recording the decrease in value of an
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
Some students mistakenly depreciate land because it’s part of property, plant, and equipment.
Land is property, but it is not depreciated because its service life never ends.
Common Mistake
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
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
Be careful not to combine the delivery truck ($40,000) and accumulated depreciation ($21,000)
Chapter 07 – Long-Term Assets
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Common Mistake
Common Mistake
Students sometimes divide by ending total assets rather than by average total assets. We measure
net income over time, whereas we measure total assets at a point in time. Therefore, whenever
Chapter 07 – Long-Term Assets
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Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
value from its actual
fair value?
value is more than the recorded book
value. A loss on sale indicates the
opposite.
How different is the
Gain or loss on sale
A gain on sale indicates the actual fair
Question
Accounting Information
Analysis
company using its
assets?
indicates a more effective use of
How effectively is the
Return on assets ratio
A higher return on assets generally
Question
Accounting Information
Analysis
How much profit is
being generated from
sales?
Profit margin
A higher profit margin indicates a
company generates a higher net
income per dollar of sales.
Question
Accounting Information
Analysis
Is the company
effectively generating
sales from its assets?
Asset turnover ratio
A higher asset turnover indicates a
company generates a higher sales
volume per dollar of assets invested.
Chapter 07 – Long-Term Assets
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Decision Maker’s Perspective
Understanding Gains and Losses
It’s tempting to think of a “gain” and “loss” on the sale of a depreciable asset as “good” and
“bad” news. For example, we commonly use the term “gain” in everyday language to mean we
sold something for more than we bought it. Gain could also be misinterpreted to mean the asset
was sold for more than its fair value (we got a “good deal”). However, neither of these represents
Strategies for Increasing Return on Assets
Companies have two primary strategies for increasing their return on assets: increasing profit
margin and increasing asset turnover. Some companies pursue a higher profit margin through
Taking a Big Bath
In practice, determining impairment losses can be subjective. Accounting research suggests that
managers sometimes use the recording of impairment losses to their advantage. Some companies
time their impairment losses with other one-time losses such as losses on sales of assets,
Chapter 07 – Long-Term Assets
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