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INSTRUCTOR’S MANUAL
8-14
Lecture Suggestions
Module 1
LO 2
Discuss examples of acquisition costs. Note, some instructors prefer to discuss the topic of capital
versus revenue expenditures (LO 7) at this point in time.
A manufacturing company produces wicker furniture. It is running short of cash and borrows
money from the bank to purchase raw materials. Is the interest on the loan included in the cost of
the inventory or is it shown on the income statement as an expense?
Students tend to believe that salvage value and estimated lives are insignificant to the overall
financial statements. They should understand that by changing these estimates, the financial
statements can be significantly impacted. It is one of the ways the management tends to “cook the
books.” An excellent example is the Waste Management fraud. In 2002, the SEC filed a complaint
against the company alleging that management fraudulently manipulated the company’s financial
results to meet predetermined earnings targets. They employed a multitude of improper accounting
practices:
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
Module 2
LO 6
Define residual value. Explain that residual value is called salvage value and/or scrap value.
Discuss how a business would choose which depreciation method to use, as well as the advantages
and disadvantages of each. The text uses the same information for all illustrations. This gives the
instructor an opportunity to compare the advantages and disadvantages of each type of
depreciation method. Give an example of how an asset is depreciated when sold during the middle
of the year. Remind students that this is an estimate and if it is later discovered that the estimate
must be changed, it does not mean that a mistake was made in the past. This is a good time to
discuss changes in estimates and the manipulation of income.
INSTRUCTOR’S MANUAL
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Projects and Activities
Module 1
LO 1
Balance Sheet Presentation
Outside assignment: Your personal balance sheet
Did you do a personal balance sheet in Chapter 1? If so, review this assignment now. Concentrate on the
assets section.
◼ Which of your assets are long-lived assets? Can you assign these a useful life and a residual value?
List the factors you considered in assigning these values.
◼ Are your personal assets depreciating? Explain.
◼ Do you have any intangible assets? What are they?
◼ What portion of your total assets are long-lived assets? You may now want to rearrange your
balance sheet to conform to the proper presentation format, separating your current and long-lived
assets.
Solution
Of course there is no “right” answer to this. The question helps the students to think of assets in real terms,
as “their” assets.
◼ Personal assets do have lives. The lives depend not on how long the item could possibly last,
Module 1
LO 3
Acquisition Cost of Assets
In-class discussion: What does it cost to acquire an asset?
Prepare a list of assets that require more than a simple purchase to be put to use. Ask students, perhaps in
teams, to list the costs that would be involved in preparing one of these assets for use. Some possible
examples are a mainframe computer system; a delivery truck; purchase of land and a building with the
intent of building the company’s new corporate headquarters on the cleared site; land holding a former
manufacturing building to be converted to an office building.
Solution
The items that students will list depend on the asset chosen (you probably have your own favorites) and the
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
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Module 2
LO 5
Depreciation of assets
In-class discussion: Nike’s asset lives
Nike included the following in a footnote to their 2015 annual report2:
Property, Plant and Equipment and Depreciation
Property, plant, and equipment are recorded at cost. Depreciation is determined on a
straight-line basis for buildings and leasehold improvements over 2 to 40 years and for
machinery and equipment over 2 to 15 years. Computer software (including in some
cases, the cost of internal labor) is depreciated on a straight-line basis over 3 to 10 years.
Software Development Costs
INSTRUCTOR’S MANUAL
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◼ By using the straight-line method of depreciation for reporting buildings and improvements, what
assumption about the usefulness of assets is the company making? Do you think this was the
primary consideration in choosing the straight-line method?
◼ What is the impact on the income statement of using accelerated methods of depreciation for tax
purposes? What is the impact on the balance sheet? What is the impact on cash?
◼ If Nike switched to accelerated depreciation on buildings and improvements for reporting
purposes, how would net income change? Would you recommend that they make this switch in
order to bring the book and tax expenses “in line?” Do you think this is a change in principle or a
change in estimate?
◼ What is the difference between a “major renewal” and a “repair”? Why is the former capitalized
and the latter expensed?
◼ How might an asset become “impaired”? Explain, citing specific examples.
Solution
◼ Straight-line depreciation assumes the asset is equally useful throughout its life. The primary
consideration in selecting a depreciation method was probably the simplicity of straight-line.
Module 2
LO 7
Capital versus Revenue Expenditures
In-class discussion: Capitalization versus expense
WorldCom was a major global communications provider, which operated in more than 65 countries.
According to a civil action brought against WorldCom by the SEC:
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
◼ What effect did WorldCom’s action have on the income statement and balance sheet? Is this effect
permanent, or a timing difference? If the effect is only a timing difference, does that make it less
of a problem?
Solution
◼ Under GAAP (Generally Accepted Accounting Principles), line fees cannot be capitalized. They
Module 2
LO 8
Disposal of Operating Assets
Outside assignment: Impact of disposals
Suppose that Time Warner owns a piece of cable television equipment with an original cost of $450,000.
Accumulated depreciation is $390,000. Consider each of the following cases separately:
◼ Time Warner sells the asset for $75,000. What is the gain or loss?
◼ Time Warner sells the asset for $50,000. What is the gain or loss?
◼ Time Warner cannot find a buyer for the asset, and pays $5,000 to have it removed. What is the
gain or loss?
INSTRUCTOR’S MANUAL
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Solution
The journal entries: (gains and losses are highlighted)
◼ To sell the asset for $75,000:
◼ This exercise demonstrates that a disposal always involves (1) removing the asset from the
balance sheet and (2) removing the related accumulated depreciation. No matter what else
happens, those two lines will be the same. The only lines in the entry that are different are the
proceeds (which may not exist, or may be a receivable, or may actually be a payment), and the
gain or loss.
◼ Most students are reluctant to accept recording a gain from a disaster. An accounting entry only
records the transaction. Obviously the follow-up will be the purchase of a new machine, using the
cash settlement. No moral or ethical problem is involved here, only the recording of an expected
cash receipt.
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
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the item insured. Companies insure for the same reason that individuals do—for protection.
Companies want to protect their assets from a catastrophic loss that might seriously impair their
ability to continue in business. For this reason, insuring for replacement cost makes good business
sense.
Outside assignment: Ethical decision: Is residual value important?
You are an assistant controller for a company with a number of operating segments. Each division has a
divisional controller who reports to the division director. These controller/director teams make many
financial decisions for their divisions, but are expected to adhere to guidelines set forth by the corporate
accounting department. Your duties include working closely with all the division controllers in gathering
and analyzing monthly operating results.
Back in your office you think over what you have found. The division is a large and very powerful one in
the company, with substantial dollars invested in equipment. Communicating this discovery to your boss,
the corporate controller, is going to put you in the middle of a politically volatile situation. You are also
concerned about how the resolution will be handled by the controller, because the success of your job has
been greatly influenced by your ability to maintain good relationships with divisional personnel, while
carrying out corporate policy.
What should you do? Consider the following items in your answer:
◼ What is a residual value? How is it determined? Why is it subtracted from cost before depreciation
expense is calculated?
◼ What impact does the choice (or lack) of a residual value have on the income statement and
balance sheet of an entity in the year the asset is purchased? During the asset’s life? In the year of
disposal of the asset?
◼ Which fundamental accounting principle(s) govern(s) this situation?
Solution
◼ A residual value is the amount the company expects to realize from the sale of an asset when it is
INSTRUCTOR’S MANUAL
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Module 3
LO 9
Intangibles
Outside assignment: Are customers a depreciable asset?
In 1987, The Herald Co., a Michigan company, merged with the Newark Morning Ledger Co., a New
◼ Are customers an asset? Do not view this from a tax perspective, where IRS rules govern, but
from what you have learned about what is or is not an asset. Are they an asset whose cost can be
reasonably estimated and recorded? If you think so, how would you value this asset? What life
would you give it?
◼ Re-read the quote from the article. Do you find an item that does not seem correct to you?
◼ What argument can you make for not capitalizing customer lists?
◼ As an accountant who has to explain in the current annual report the potential results of this
litigation, draft a memo to management with your opinion as to the outcome of this case. The
memo should include your answers to the above questions.
Solution
This is an old case with some interesting theories. It is still applicable today. How does Microsoft value the
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
In-class discussion: Amortization versus depreciation
Depreciation of plant, property, or equipment is credited not to the asset account itself, which is maintained
at historical cost, but to a separate contra asset, Accumulated Depreciation. However, amortization of
intangibles is often credited directly to the asset. What characteristics of intangible assets versus tangible
assets can you name that would explain this difference in treatment?
Solution
Property, plant, and equipment are “things.” That is, they have physical substance. They age as you use
In-class discussion: Intangibles and research and development expenses
Merck is an international, research-based pharmaceutical company. Its annual report for 20145 contains the
following information in the footnotes:
INSTRUCTOR’S MANUAL
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reflected as a reduction of research and development expenses when the specific milestone has been
achieved. Nonrefundable advance payments for goods and services that will be used in future research and
development activities are expensed when the activity has been performed or when the goods have been
received rather than when the payment is made. Research and development expenses include restructuring
costs and IPR&D impairment charges in all periods. In addition, research and development expenses in
2014 include a charge to increase the fair value of a liability for contingent consideration.
Acquired Intangibles — Acquired intangibles include products and product rights, tradenames and patents,
which are recorded at fair value, assigned an estimated useful life, and are amortized primarily on a
straight-line basis over their estimated useful lives ranging from 3 to 20 years (see Note 7). The Company
◼ Merck’s intangible assets (Goodwill and Identifiable intangible assets, less accumulated
amortization) comprises 34%6 of its total assets and research and development and amortization of
intangibles comprise 20% 7of its operating expenses. Is this what you would expect of a
pharmaceutical company?
◼ How does Merck account for R & D expenses? Is this is conformity with GAAP?
◼ What do you think they mean by a “specific Milestone”?
◼ How would Merck account for a patent that is on their books that has been unsuccessfully
defended in a lawsuit?
◼ How are R & D costs handled under IFRS?
Solution
◼ Yes, research and development costs are the lifeblood of a pharmaceutical company. It may take
CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES
Decision
Models Ethics Decision Making Model
You are the accountant for a small messenger/delivery service company that owns a fleet of six minivans.
Each driver is responsible for scheduling routine maintenance on his or her van, including oil changes,
tune-ups, and tires. The owner of the company learned that one of the drivers has neglected to schedule
regular maintenance. His van, which is 1.5 years old, has never had an oil change. Recently, the van came
to a sudden, permanent halt during its delivery rounds. The garage said that the damage to the engine is so
severe that the engine must be replaced. The mechanic can install a rebuilt engine for a cost of $6,000.
The company’s owner is upset about the expenditure and its potential impact on the company’s operating
results. He wants to capitalize the $6,000, and add two years to the original life of the van.
Using the Ethics Decision Making Model, determine what you should do.
1. Recognize an ethical dilemma. Should you expense or capitalize the $6,000 spent to overhaul the
engine.
2. Analyze the key elements in the situation.
• Who will benefit? The owner will benefit because the financial statements will improve
bias, and material error.
3. Determine what alternative methods are available to report the transaction, situation or
event.
• There are two alternative methods to report the transaction:
a. Report the $6,000 spent to overhaul the engine as a repair expense of the period.
b. Report the $6,000 as a capital item and depreciate it over the remaining useful life.
INSTRUCTOR’S MANUAL
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