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Financial accounting the impact on decision makers 9e chapter 8

Chapter 8
Operating Assets: Property, Plant,
and Equipment, and Intangibles


Operating Assets


Two categories of operating assets presented on the
balance sheet:



Property, Plant and Equipment
Intangible Assets

Presented at their acquisition cost (historical cost)
 Essential to a company’s long-term future







Used to produce the goods or services the company sells to
customers

Constitute the major productive assets of many
companies
LO 1


Balance Sheet Presentation of
Property, Plant, and Equipment
 Balance

sheet uses one line item for property,
plant, and equipment and presents the details
in the notes


Acquisition of Property, Plant, and
Equipment
 Initially

recorded at acquisition cost or original

cost
 Includes all cost normally necessary to acquire
an asset and prepare it for its intended use
 Purchase

price
 Taxes paid at time of purchase (for example, sales
tax)
 Transportation charges
 Installation costs
LO 2


Group Purchase

 Firm

purchases several assets as a group and
pays a lump-sum amount
 Acquisition cost of each asset is separately
measured on the basis of the proportion of the
fair market value of each

LO 3


Example 8.1—Determining Cost When
a Group of Assets Is Purchased


Assume that on January 1, ExerCo purchased a building and the
land on which it is situated for $100,000. The accountant
established the assets’ fair market value on January 1 as follows:



Based on the estimated market values, purchase price should be
allocated as follows:
To land

$100,000 × $30,000/$120,000 = $25,000

To building

$100,000 × $90,000/$120,000 = $75,000


Example 8.1—Determining Cost When a
Group of Assets Is Purchased (continued)
The effect of the transaction can be identified and
analyzed as follows:


Capitalization of Interest
 The

interest on borrowed money should be
treated as an expense of the period
 If a company constructs an asset over a period
of time and borrows money to finance the
construction
 The

interest incurred during the construction period
is not treated as interest expense
 The interest must be included as part of the
acquisition cost of the asset
LO 4


Land Improvements
 The

acquisition cost of land should be kept in a
separate account because land has an unlimited
life and is not subject to depreciation
 Costs associated with land should be recorded
in an account such as Land Improvements
 Example:

Costs of paving a parking lot and
landscaping costs
• Have a limited life
• Should be depreciated over their useful lives


Use and Depreciation of Property,
Plant, and Equipment
 Depreciation:

allocation of the original cost of
an asset to the periods benefited by its use
 An asset’s decline in usefulness is related to:
 Physical

deterioration from usage or from the
passage of time
 Obsolescence factors such as changes in technology
 The company’s repair and maintenance policies

LO 5


Use and Depreciation of Property,
Plant, and Equipment
 Methods




of depreciation:

Straight-line
Units-of-production
Accelerated depreciation

 The

method chosen should be one that best
matches the expense to the revenue generated
by the asset


Straight-Line Method
 Allocates

the cost of the asset evenly over time


Example 8.2—Computing Depreciation
Using the Straight-Line Method


Assume that on January 1, 2014, ExerCo, a manufacturer of
exercise equipment, purchased a machine for $20,000. The
machine’s estimated life would be five years, and its residual
value at the end of 2018 would be $2,000. The annual
depreciation should be calculated as follows:



The book value at the end of 2014


Example 8.2—Computing Depreciation
Using the Straight-Line Method (continued)


The book value at the end of 2014


Units-of-Production Method
 Depreciation

is determined as a function of the
number of units the asset produces


Example 8.3—Computing Depreciation
Using the Units-of-Production


ExerCo has estimated that the total number of units that will be
produced during the asset’s five-year life is 18,000. During 2014,
ExerCo produced 4,000 units. The depreciation per unit for
ExerCo’s machine can be calculated as follows:



The book value at the end of 2014


Accelerated Depreciation Method
 Higher

amount of depreciation is recorded in
the early years than in later years
 Double-declining-balance method: recorded at
twice the straight-line rate, but the balance is
reduced each period


Example 8.4—Computing Depreciation
Using the Double-Declining-Balance Method


Assume that ExerCo wants to depreciate its asset using the doubledeclining-balance method. The first step is to calculate the straightline rate as a percentage. The straight-line rate for the ExerCo asset
with a five-year life is as follows:



The second step is to double the straight-line rate, as follows:



The amount of depreciation for 2014



The amount of depreciation for 2015


Example 8.4—Computing Depreciation
Using the Units-of-Production (continued)
The complete depreciation schedule for ExerCo for all five years of
the machine’s life would be as follows:


Exhibit 8.1—Comparison of Depreciation and Book Values
of Straight-Line and Double-Declining-Balance Methods


Exhibit 8.2—Management’s Choice of
Depreciation Method


Changes in Depreciation Estimate
 Change

in the life of the asset or in its residual

value
 Recorded prospectively
 The

depreciation recorded in prior years is not
corrected or restated
 The new estimate should affect the current and
future years

LO 6


Example 8.5—Calculating a Change in
Depreciation Estimate


$20,000 machine originally expected to be depreciated
over 5 years. After 2 years, useful life is increased to 7
years
$3,600

$3,600

2012

2013

Depreciation

2014

revise
estimate
From 5 years to 7 years

2015

2016


Example 8.5—Calculating a Change in
Depreciation Estimate (continued)

$3,600

$3,600

$2,160

$2,160

$2,160

$2,160

$2,160

2012

2013

2014

2015

2016

2017

2018

revise
estimate

Depreciation


Example 8.5—Calculating a Change in
Depreciation Estimate (continued)
 In

Example 8-5, the effect of the transaction can
be identified and analyzed as follows:


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