Chapter 8: Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles

Long-lived assets can be purchased with:

Cash Debt Equity Other non-cash considerations

Capitalize

put on the balance sheet rather than expense immeidately

Research and Development

• The cost of developing an intangible asset internally • Research and development expenditures typically do not possess sufficient probability of resulting in measureable cash flows • NOT AN INTANGIBLE ASSET UNDER U.S. GAAP • Under most situations, these costs are expensed immediately

goodwill

• The excess of the purchase price of a business over the fair value of the business assets and liabilities • Typically, goodwill can only be recorded as an intangible asset when purchasing another company • Internally generated goodwill isn't capitalized but generally reflected in the stock price • Indefinite life and is tested for impairment on an annual basis

Depreciation

• The process of allocating the cost of a tangible asset over its productive life using a systematic and rational method • Matches the costs of the tangible asset with the revenues that they generate • A process of cost allocation, not a process of determining an asset's current market value or worth • After acquisition, the asset is not measured at fair market value (what the item could be sold for today) on the balance sheet

Accumulated depreciation

• a contra asset account • It's companion account is Property, Plant, and Equipment • The ending balance of represents the accumulation of depreciation expense recorded since the acquisition date of the asset

cost allocation methods

• straight-line (most common depreciation method used, allocates the cost of the asset in equal periodic amounts over its useful life) • units-of-production • declining-balance (most frequently used accelerated method of depreciation)

Declining-balance

(Cost-accumulated depreciation) X (rate/useful life) = depreciation expense (for double declining balance, rate=2, one-and-a-half-declining balance, rate=1.5)

Straight-line cost allocation

(Cost-residual value) X (1/useful life) = depreciation expense

Depletion

(Cost-residual value)/estimate total depletion X actual depletion

Units-of-production

(Cost-residual value)/estimate total production X actual production = depreciation expense

Accounting for changes in depreciation estimates

(Net book value-new residual value) X (1/remaining life) = depreciation expense

If a company wanted to fraudulently lower their depreciation expense, what inputs to the depreciation expense calculation could they easily manipulate?

...

Two journal entries required in conjunction with the disposal of an asset

1) An adjusting entry to update the depreciation expense and accumulated depreciation (Usually required because the disposal of an asset seldom occurs on the last day of the accounting period) 2) An entry to record the disposal of the asset (Both the cost of the asset and any accumulated depreciation must be removed from the financial statements)

Two step process of reviewing assets for possible impairments

1) Test the asset for impairment: if Net Book Value > Estimated Future Cash Flows, then asset is impaired 2) Computation of Impairment Loss: Impairment Loss = Net Book Value - Fair Value

types of tangible long-lived assets

1) land 2) buildings, fixtures, equipment 3) natural resources

Net book (carrying value) of a long-lived asset

Acquisition cost-accumulated depreciation

What's capitalized during the construction of the asset

All expenditures associated with the construction of the asset E.g., labor, materials, and the interest incurred during the construction period

Depreciation expense

Amount reported on the income statement for each period

trademarks

An exclusive legal right to use a special name, image, or slogan

copyrights

An exclusive right to publish, use and sell and literary, musical, or artistic work

Calculating gain or loss from the sale of an asset (b/c an asset's book value doesn't generally reflect its FMV)

Assets received upon disposal (e.g. cash or other asset)-net book value = gain (loss) on sale of asset (Generally, the gain or loss on sale of assets is NOT part of operating income on the income statement)

journal entry to record the difference when LIFO COGS is lower than FIFO COGS

DR LIFO reserve CR cost of goods sold

Journal entry when the mined or harvested natural resource is sold

DR accounts receivable or cash CR revenue AND DR cost of goods sold CR inventory

Journal entry to record the use of an intangible asset with a definite useful life

DR amortization expense CR accumulated amortization or intangible asset

journal entry to record the difference when LIFO COGS is higher than FIFO COGS

DR cost of goods sold CR LIFO reserve

journal entry to account for LIFO adjustment

DR cost of goods sold CR LIFO reserve (Only needed if company keeps track of inventory using FIFO but reports inventory using LIFO)

Journal entry used to record depreciation

DR depreciation expense CR accumulated depreciation

Journal entry when natural resources are mined or harvested

DR inventory CR accumulated depletion or natural resources

The LIFO adjustment/reserve

Difference subtracted from FIFO amount to get ending LIFO amount

Recording long-lived assets

Do it at historical cost unless the net book value becomes greater than the asset's estimated future cash flows (A la the lower-of-cost of market value rule applied to inventory)

General rule regarding post-acquisition expenditures

Expense the cost if it only benefits the current period Capitalize the cost it if increases future benefits

What happens when you capitalize an expenditure rather than expensing it

Increases current period net income Allows the company to spread the expense over a longer period of time rather than recognize it all during the current period [why Worldcom improperly capitalized $3.8 BILLION of assets]

intangible long-lived assets

Non-physical items that confer specific rights on the their owner (ex: patents, copyrights, trademarks, franchises, goodwill, licenses)

estimated residual (salvage) value at the end of the asset's useful life

Management's estimate of the amount the company expects to recover upon disposal of the asset at the end of its useful life

estimated useful life to the company

Management's estimate of the asset's useful economic life to the company rather than its total economic life to all users

License and Operating Rights

Obtained through the agreements with governmental units or agencies, permit owners to use public property in performing their services

Where is the net book (carrying value) reported in the financial statements?

On the balance sheet as property, plant, and equipment, net

tangible long-lived assets

Physical items that are classified as property, plant, and equipment or fixed assets

calculating goodwill

Purchase price-fair market value of net assets = goodwill to be reported

long-lived assets

Tangible and intangible resources owned by a business and used in its operations over several years. Can be constructed.

The rule about which costs associated with the acquisition of a long-lived asset are capitalized

all reasonable and necessary expenditures made in acquiring and preparing an asset for use should be recorded as the cost of the asset and capitalized (Special discounts are subtracted from the acquisition cost of long-lived assets)

Examples of natural resources

gold, iron ore, oil wells, timber tracts

Things capitalized as long-lived assets

improvements, purchase price, sales taxes, transportation fees, legal fees, installation costs

Do we depreciate tangible assets w/unlimited useful lives (i.e. land)?

no

If the net book value of the asset does become greater than the estimated future cash flows of the asset

record an asset impairment loss to decrease the net book value of the asset to its fair market value.

types of long-lived assets

tangible, intangible

Calculating amortization expense

use the straight-line method

Ordinary repairs and maintenance expenditures

• Expenditures for the normal maintenance and upkeep of long-lived assets • Recurring in nature • Relatively small amounts • Do not directly increase the productive life, operating efficiency, or capacity of the asset • Expensed

Additions and Improvements (capital expenditures)

• Expenditures that increase the productive life, operating efficiency, or capacity of the asset • Increase the efficiency or life of the asset • Capitalized E.g. Additions, Major overhauls, Complete reconditioning, Major replacements, Improvements

patents

• Granted by the federal government for an invention; it is an exclusive right given to the owner to use, manufacture, and sell the subject of the patent • If developed internally, the registration and legal costs can be capitalized

Intangible assets

• Non-physical items that confer specific rights on the their owner • We do not capitalize internally generated intangible assets. Internally generated intangible assets are expensed when incurred • Ones with definite lives are amortized • We record intangible assets at historical cost only when they have been purchased. • E.g., patents, copyrights, trademarks, goodwill, licenses

Intangible assets with indefinite lives

• Not amortized • tested annually for impairments (with a test similar to that for tangible assets)

Tangible assets with a limited useful life

• Represents the prepaid cost of a bundle of future services or benefits • Matching principle requires that a portion of the asset's cost be allocated as an expense in the same period that revenues are generated by its use