Agenda Chapter 8

• Types of long-lived assets

• Tangible, intangible & natural resources (LO8-1)
• Long-lived Asset Life Cycle
o Acquisition (LO8-2)
o Repairs, maintenance & improvements (LO8-02)
o Depreciation (LO8-3)
o Asset impairment (LO8-4)
o Disposal (LO8-5)
• Intangible assets & natural resources (LO8-6)
• CH 8 Practice
 Classified as:
Long-lived 1. Tangible assets
Assets 2. Intangible Assets
3. Natural resources
 Tangible assets have physical substance. You can TOUCH them.
This category is further divided into two classifications:
Tangible a. Property subject to depreciation such as buildings and
Assets equipment.
b. Land, which is not subject to depreciation due to its unlimited
term of existence and utility that does not decline over time.
 Intangible assets describe noncurrent assets that are used
in the operation of the business but have no physical
Intangible qualities – you CANNOT TOUCH them.
Assets Examples include patents, copyrights, trademarks,
franchises, and goodwill.
Natural Resources
Natural resources A site acquired for the purpose of extracting or removing some
valuable resource. For example, coal, diamonds, water, oil, minerals, ti mber.
Accountable Transactions – Long Term
Assets

Use of the asset

Acquisition (Allocation of the acquisition Sale or disposal
cost to expense over the
asset’s useful life)
 Land Equipment Building The cost of a plant
purchase price purchase price purchase price
asset includes all
closing costs (e.g., title to the
land, attorney’s fees, &
freight and handling
charges
closing costs (e.g., title
to the building,
attorney’s fees, &
expenditures that are
recording fees)
recording fees)
reasonable and
costs of grading, filling,
draining, and clearing
cost of special
foundations if
professional fees and
building permits
necessary for
required
(1) getting the asset
assumption of any liens,
mortgages, or encumbrances
insurance on the
equipment while in
materials, labor, and
overhead costs incurred to the desired location
and (2) ready for use.
on the property transit during construction

additional land improvements assembling and

that have an indefinite life installation costs

costs of conducting NOTE - WE SAY THAT THE EXPENDITURES ARE

trial runs CAPITALIZED WHEN THEY ARE RECORDED AS AN ASSET.
Land
Improvemen
ts
Land improvements have
limited lives separate from
the land and are subject to
depreciation. For this
reason, they are recorded in
a separate account.
Examples include:
◦ Driveways
◦ Fences
◦ Parking lots
◦ Landscaping
◦ Sprinkler systems Land improvements are depreciable because there is
wear and tear over time
Buildings
Buildings are sometimes
purchased with the intention of
remodeling them prior to placing
them in use.
Costs incurred under these
circumstances are charged to the
Buildings account.
After the building has been placed
in use, however, ordinary repairs
are considered to be maintenance
expense when incurred.
 When equipment is purchased, all of the sales taxes, delivery costs,
and costs of getting the equipment in good operating order are
treated as part of the cost of the equipment.
Equipment Once the equipment has been placed in operation, maintenance
costs (including interest, insurance, and property taxes) are treated
as expenses of the current period.
Accountable Transactions – Long Term
Assets

Use of the asset

Acquisition (Allocation of the Sale or disposal
acquisition cost to expense
over the asset’s useful life)
 Accounting
Type of Expenditure Identifying Characteristics Treatment

1. Maintains the productive capacity of the asset during the

current accounting period only
Ordinary repairs and 2. Recurring in nature Expense in the
maintenance 3. Involve small amounts period incurred
4. Do not increase the productive life, operating efficiency,
or capacity of the asset

1. Increase the productive life, operating efficiency, or

Improvements capacity of the asset Add to asset
2. Occur infrequently account (Capitalize)
3. Involve large amounts of money

Repairs, Maintenance, & Improvements

 See CH 8 Excel
Example Acquisitions & Repairs Problems

For each of the following transactions, perform a transaction analysis

1) Purchased a patent, $4,300 cash..
2) Purchased a machine, $7,000; gave a long-term note.
3) Paid freight for the machine, $225 cash.
4) Paid for routine maintenance, $200, on credit.
5) Paid $400 for ordinary repairs.
6) Paid $20,000 cash for addition to old building.
7) Paid $3,500 cash for a sprinkler system including installation for the plantings around
the headquarters building.
Depreciation Terms
Salvage Value Accumulated Depreciation
◦ Estimated amount that a company ◦ Contra-asset
will receive when it sells the asset or ◦ Represents the portion of an asset’s
◦ Asset’s fair value when removed cost that has already been allocated
from service to expense
Useful Life Net Book Value
◦ Estimate of how long the asset will ◦ Cost – Accumulated Depreciation
be in productive use by the current Causes of Depreciation
owner ◦ Physical deterioration
◦ Obsolescence
Depreciation Methods
The 3 most common methods are
1. Straight-line method: The same amount is
depreciated each accounting period.
2. Units-of-production: Produces varying amounts
of depreciation in different accounting periods
depending upon the number of units produced.
3. Declining-balance: Produces more depreciation
expense in the early years of an asset’s life, with
a declining amount of expense in later years.
 Straight-Line Method

Notice that:
• Depreciation expense is a constant
amount each year.
• Accumulated depreciation increases by
an equal amount each year.
• Net book value decreases by the same
amount each year until it equals the
estimated residual value.

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Example: Straight-Line
Depreciation
On January 2, S&G Wholesale Grocery
acquires a new delivery truck. The truck cost
$17,000, has an estimated residual value of
$2,000, and an estimated useful life of five
years.
Compute annual depreciation using the
straight-line method.
 Straight-Line Depreciation: Example
S&G will record $3,000 depreciation each year for five
years. Total depreciation over the estimated useful life of
the equipment is:

Depreciation Accumulated Accumulated Undepreciated

Year Expense Depreciation Depreciation Balance
(DR) (CR) Balance (Book Value)
Beginning $17,000
First $3,000 $3,000 $3,000 14,000
Second 3,000 3,000 6,000 11,000
Third 3,000 3,000 9,000 8,000
Fourth 3,000 3,000 12,000 5,000
Fifth 3,000 3,000 15,000 2,000
Total $15,000 $15,000

Salvage
Salvage Value
Value
Depreciation
for Fractional
Periods
When an asset is acquired during
the year, depreciation in the year
of acquisition must be prorated.
Half-Year Convention
In the year of acquisition, record
six months of depreciation
whether the asset was acquired
on January 15th or December 31st
Example: Half-Year Convention
An insurance company purchases hundreds of desktop computers
throughout the current year at a total cost of $600,000. The
company depreciates these computers by the straight-line method,
assuming a three-year life and no residual value.
What should the company record, assuming they use the half-year
convention?
 Units-of-Production Method
Herrs purchased packaging equipment for $101,500 cash. The
equipment has an estimated useful life of 22,500 hours and an
estimated residual value of $2,500.
If the equipment is used 3,950 hours in the first year, what is the
amount of depreciation expense?
Units of Production Formula:

( 𝐶𝑜𝑠𝑡 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙𝑉𝑎𝑙𝑢𝑒
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 )× 𝐴𝑐𝑡𝑢𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛=𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝

(
$ 101,500 − $ 2,500
22,500 )=$ 4.40 𝑝𝑒𝑟 h𝑜𝑢𝑟 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒

( $ 4.40 ) ×,3,950𝑎𝑐𝑡𝑢𝑎𝑙h𝑜𝑢𝑟𝑠=$ 17,380

Declining- Depreciation in the early years of an asset’s
Balance estimated useful life is higher than in later years.
Method

An accelerated Accelerated
Accelerated
Depreciation Remaining
Depreciation = Remaining × Depreciation
depreciation Expense
Expense
= Book Value × Depreciation
Book Value Rate
Rate
method

For
For example,
example, the
the double-declining-balance
double-declining-balance
depreciation
depreciation rate
rate isis 200
200 percent
percent of
of (double)
(double)
the
the straight-line
straight-line depreciation
depreciation rate
rate
 Double Declining Balance (DDB)
Method
Herrs purchased packaging equipment for $101,500 cash.
The equipment has an estimated useful life of 10 years and
an estimated residual value of $2,500.
If the company uses the double declining balance method,
what is the amount of depreciation expense?
Double Declining Balance Formula:

1
( 𝐶𝑜𝑠𝑡 − 𝐴𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝐷𝑒𝑝𝑟 ) × 2× =𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝
𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒
1
( $ 101,500 −0 ) × 2 × =$ 20,300 ANNUAL COMPUTATION IGNORES RESIDUAL
10 𝑦𝑟𝑠
VALUE.
Method Formula Depreciation Expense
Straight-line (Cost − Residual Value) × 1/Useful Equal amounts each year
Life
Units-of-production [(Cost − Residual Value)/Estimated Varying amounts based on
Total Production] × Annual production level
Production

Double-declining-balance (Cost − Accumulated Depreciation) Declining amounts over time

× 2/Useful Life

Summary of the three depreciation methods

Depreciation Practice
Maserati Corporation purchased a new machine for its assembly process on
August 1, 2022. The cost of this machine was $150,000. The company
estimated that the machine would have a salvage value of $24,000 at the end
of its service life. Its life is estimated at 5 years and its working hours are
estimated at 21,000 hours. Year-end is December 31.
Instructions: Compute the depreciation expense under the following methods.
(a) Straight-line depreciation.
(b) Activity method (Assume 800 hours used in 2022)
(c) Double-declining balance.
 Straight-Line
Vs. Accelerated

Over the entire life of the asset, however, both the

straight-line method and accelerated methods recognize
the same total amount of depreciation.
 An asset’s book value is impaired when the asset is not
expected to generate sufficient cash flows (probable
future benefits) at least equal to its book value.
Step 1: Test for Impairment Impairment occurs when
events or changed circumstances cause the estimated
future cash flows (future benefits) of these assets to
Measuring fall below their book value.
Asset If net book value > Estimated future cash flows, then
Impairment the asset is impaired
Step 2: Computation of Impairment Loss For any asset
considered to be impaired, companies recognize a loss
for the difference between the asset’s book value and
its fair value (a market concept). The asset is written
down to fair value.
Impairment Loss = Net Book Value – Fair Value
Example: Asset Impairment
Assume that Herrs did a review for asset impairment and identified a machine with the following
information:
◦ Machinery $3,000,000
◦ Accumulated depreciation, $1,123,000
◦ Estimated future cash flows $1,575,000
◦ Fair Value $1,270,000

Step 1: Does the net book value exceed the estimated future cash? If so, the asset is impaired.
Step 2: Calculate any loss as net book value less fair value
What journal entry would be recorded:?
Accountable Transactions – Long Term
Assets

Use of the asset

Acquisition (Allocation of the Sale or disposal
acquisition cost to expense
over the asset’s useful life)
Disposal of Plant and Equipment
Update depreciation
to the date of disposal.

If Cash > NBV, record a gain (credit).

If Cash < NBV, record a loss (debit).
If Cash = NBV, no gain or loss.

Record cash Record a

received gain or loss

Remove accumulated Remove the

depreciation asset cost
Example: Disposal
Assume that a machine costing $10,000 had accumulated
depreciation of $8,000 and book value of $2,000 (10,000 − $8,000)
at the time it was sold for $3,000 cash.
Determine the gain or loss on sale of this machine.

Cost of machine
Accumulated depreciation
Book value at time of sale
Cash received
Gain on sale of machine
Tangible Vs.
Intangible
Assets

For an expenditure to qualify as an intangible asset, there must

be reasonable evidence of future benefits.
Expenditures that will be used > 1year
Expenditures used < 1 year = EXPENSE
Intangible Assets:
Characteristics
Intangible assets are long-term assets with no
physical substance.
They are used in the operation of the business
to generate income.
The valuation basis is cost.
Common examples include:
◦ Patents
◦ Trademarks
◦ Goodwill
Goodwill
Goodwill represents an amount that a company has
paid to acquire certain favorable intangible attributes
as part of an acquisition of another company. Positive
attributes often included in goodwill are:
◦ Favorable reputation
◦ Positive market share
◦ Positive advertising image
◦ Reputation for high quality and loyal employees
◦ Superior management
◦ Manufacturing and other operating efficiency
Franchises
A franchise is a right granted by a company or a governmental
unit to conduct a certain type of business in a specific
geographical area.
An example of a franchise is the right to operate a McDonald’s
restaurant in a specific geographic region.
The cost of franchises varies greatly and often is quite substantial.
When the cost of a franchise is small, it may be charged
immediately to expense or amortized over a short period such as
five years.
When the cost is material, amortization is based on the life of the
franchise (if defined by the franchise agreement); the
amortization period, however, should not exceed the period the
franchise is expected to generate revenue.
 A copyright is an exclusive right granted by the federal government to protect the
production and sale of literary or artistic materials for the life of the creator plus 70
years.

Copyrights The cost of obtaining a copyright may be minor and therefore is chargeable to
expense when paid.
Only when a copyright is purchased from an existing owner will the expenditure be
material enough to warrant its being capitalized and spread over the useful life.
 Example: Goodwill
Goodwill: The excess of cost over fair Bendigo's Restaurant
value of net tangible assets acquired in Balance Sheet
At December 31, Year 1
a business acquisition.
Assets $ 200,000
Assume that a buyer is willing to pay
$300,000 cash to acquire Bendigo’s to Liabilities $ 50,000
purchase assets with a fair value of Stockholders' Equity 150,000
$280,000. The buyer will also assume Total $ 200,000
the $50,000 liabilities.

= +
Assets Liab Stockholders' Equity

+ Seller = Seller + Common + Retained − =

Cash Assets Good-will Liab. Stock Earnings Revenue Expense Net Inc. Cash Flow

+ = + + − = 8-38
(300,000) 280,000 70,000 50,000 n/a n/a n/a n/a n/a (300,000) IA
 Amortization
Although it is difficult to estimate the useful life of an intangible such as a
trademark, like most plant assets it is probable that such an asset will not
contribute to future earnings on a permanent basis.

The cost of the intangible asset should, therefore, be deducted from

revenue during the years in which it may be expected to aid in producing
revenue.

The straight-line method normally is used for amortizing intangible

assets.

The usual accounting entry for amortization consists of a Debit to

Amortization Expense and a Credit to Intangible Asset
Example: Amortization
Flowers Industries purchased a newly granted patent for $44,000
cash. Although the patent has a legal life of 20 years, Flowers
estimates that it will be useful for only 11 years. The annual
amortization charge is therefore $4,000 ($44,000 ÷ 11 years).

+
Assets = Liab. Stockholders' Equity

=
+ Common + Retained −
Cash + Patent = Stock Earnings Revenue Expenses Net Income Cash Flow

− =
+ +
(44,000) + 44,000 = n/a n/a n/a n/a n/a n/a (44,000) IA

n/a (4,000) n/a n/a (4,000) n/a 4,000 (4,000) n/a

 Accounting for
Natural Resources
The distinguishing characteristic of
natural resources is that they are
physically removed from their natural
environment and converted into
inventory.
Examples include:
◦ Mining properties
◦ Oil
◦ Gas reserves
◦ Tracts of timber
 Natural Resources
A mine or an oil reserve does not depreciate, but it is gradually depleted as the natural
resource is removed from the ground. Once all of the coal has been removed from a coal
mine, for example, the mine is fully depleted and will be abandoned or sold for its residual
value.
1. There are two steps to calculate depletion, beginning with finding the depletion charge per
unit of resource.
Cost − Salvage Value = Depletion charge per
Total estimated units recoverable unit of resource

2. Then multiply the resulting depletion charge per unit of resource by units extracted and
sold in the current period to find the periodic depletion expense.
Number of units
Depletion charge per Periodic Depletion
× extracted and sold this =
unit of resource Expense
period

8-42
 Example: Natural Resources
Apex Coal Mining paid $4,000,000 cash to purchase a mine expected
to yield 16,000,000 tons of coal. After all coal is extracted the mine is
not expected to have any salvage value.
During the year, the company extracted and sold 360,000 tons of coal.

= +
Assets Liab. Stockholders' Equity

+ = + Common + Retained − = Net

Cash Coal Mine Stock Earnings Revenue Expense Income Cash Flow

+ = + + − =
(4,000,000) 4,000,000 n/a n/a n/a n/a n/a n/a (4,000,000) IA
n/a (90,000) n/a n/a (90,000) n/a 90,000 (90,000) n/a n/a

8-43
 Problem 8-8
During the current year ending on December 31, BSP Company completed the following transactions:
a) On January 1, purchased a patent for $30,100 cash (estimated useful life, seven years).
b) On January 1, purchased the assets (not detailed) of another business for $152,000 cash, including
$10,000 for goodwill. The company assumed no liabilities. Goodwill has an indefinite life.
c) On December 31, constructed a storage shed on land leased from D. Heald. The cost was $14,600. The
company uses straight-line depreciation. The lease will expire in four years. (Amounts spent to enhance
leased property are capitalized as intangible assets called Leasehold Improvements.)
d) Total expenditures for ordinary repairs and maintenance were $4,800 during the current year.
e) On December 31 of the current year, sold Machine A for $7,200 cash. Original cost was $20,000;
accumulated depreciation to December 31 of the prior year was $12,640 (on a straight-line basis with a
$4,200 residual value and five-year useful life). Record the depreciation expense in transaction e(1) and
the sale in transaction e(2).
f) On December 31 of the current year, paid $5,500 for a complete reconditioning of Machine B acquired on
January 1 of the prior year. Original cost, $43,200; accumulated depreciation to December 31 of the prior
year was $2,500 (on a straight-line basis with a $8,200 residual value and 14-year useful life).
Objective of GAAP versus Tax
Reporting
Financial Reporting (GAAP) Tax Reporting (IRC)
The objective of financial The objective of the Internal Revenue
reporting is to provide economic Code is to raise sufficient revenues to
information about a business that pay for the expenditures of the federal
is useful in projecting future cash government.
flows of the business.

Financial reporting rules follow Many of the Code’s provisions are

generally accepted accounting designed to encourage certain
principles. behaviors that are thought to benefit
society.
 Financial Reporting (GAAP) Tax Reporting (IRC)
Managers determine which depreciation method provides the When given a choice managers will apply the least and latest rule.
best matching of revenues and expenses. All taxpayers want to pay the lowest amount of tax that is legally
permitted and at the latest possible date.

Choose the straight line method (the most common and easy
to use) if the asset provides benefits evenly over time. During
the early years of an asset’s life, the straight-line method
reports higher income than the accelerated methods do.

Choose an accelerated method if assets produce more

revenue in their early lives.

How Managers Choose

©2020 McGraw-Hill Education.

MACRS
Most businesses use MACRS (Modified Accelerated Cost Recovery
System) in their federal income tax returns.
Some small businesses also use this method in their financial
statements, so they do not have to compute depreciation in several
different ways.

KEY POINT
For publicly traded companies, the use of MACRS in financial
statements is usually not considered to be in conformity with
generally accepted accounting principles.
Reminders
• Read Ch. 8
• Watch Connect Video ​to
supplement reading & lecture
• Ch. 8 Homework ​
• due Sunday at 11:30 pm EDT
• Quiz #7
• In class this Wednesday
(11/08)