6-1

CHAPTER 6

Accounting for and Presentation of Property, Plant, and Equipment, and Other

Noncurrent Assets

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

6-2

Noncurrent Assets

Land

Equipment

Buildings

Intangible Assets

Natural Resources

1) Classified as Assets because they are owned by the organization

2) Have the ability to generate Revenue beyond 1 year

6-3

Decline in asset value over its useful life

Primary Issues for Noncurrent Assets

AcquisitionAccounting for

acquisition of the asset.

UseAccounting for

depreciation of the asset.

Accounting for maintenance and

repair costs.

DisposalAccounting for the disposition of the

asset.

6-4

Land is a non-depreciable asset.

Purchaseprice

Real estatecommissions

Title insurance premiumsDelinquent

taxes

Razing costs of building on the land

Title and legal fees

LandAll costs incurred to get land ready for use are

capitalized.

L O 1

6-5

LandAssume that a company pays $250,000 to purchase land and get it ready for use in its

business on January 01.The following journal entry would be made to

capitalize the $250,000:

L O 1

6-6

Land

If 5 years later, on January 01 that same piece of land is sold for $300,000, the entry to

record the sale would be:

L O 1

6-7

On January 1, UpCo purchased land and building for $200,000 cash. The appraised values are building,

$162,500, and land, $87,500.

How much of the $200,000 purchase price will be charged to the building and land accounts?

Basket PurchaseThe total cost of a combined

purchase of land and a building is allocated to each asset on the

basis of relative market values and each asset is recorded separately.

L O 1

6-8

Appraised % of Purchase ApportionedAsset Value Value Price Cost

a b* c b × cLand 87,500$ 35% × 200,000$ = 70,000$ Building 162,500 65% × 200,000 = 130,000 Total 250,000$ 100% 200,000$

* $87,500 ÷ $250,000 = 35%

$162,500 ÷ $250,000 = 65%

Basket PurchaseL O 1

6-9

Purchaseprice

Architecturalfees

Cost ofpermits

Excavation andconstruction costs

Installationcosts

Transportationcosts

Buildings and EquipmentL O 1

All costs incurred to get an asset ready for use are capitalized.

6-10

Depreciation is the allocation of the cost of an asset to the years in which the

benefits of the asset are expected to be received. It is an application of the

matching concept.

CostAllocation

AcquisitionCost

(Unused)

Balance Sheet

(Used)

Income Statement

Expense

DepreciationL O 2

Does not reflect decline in value

6-11

Depreciation expense is recorded in each fiscal period.

GENERAL JOURNAL

Date Account Titles and ExplanationPRDebit Credit

XXX XX Depreciation Expense $$$$Accumulated Depreciation $$$$

Contra-asset

DepreciationL O 2

Contra-asset accounts Contra-asset accounts are used to segregate are used to segregate

depreciation from depreciation from original costoriginal cost

6-12

Balance Sheet Presentation

Depreciation

Net Book Value (NBV)

L O 2

6-13

IncomeStatement

DepreciationExpense

Depreciation forthe current year

BalanceSheet

AccumulatedDepreciation

Total depreciation recordedas of balance sheet date

DepreciationL O 2

6-14

Depreciation Methods

In the early years of an asset’s life, accelerated depreciation methods result in greater depreciation expense and lower net

income than straight-line depreciation.

Straight-Line Depreciation

Years of Life

Annu

al

Depr

ecia

tion

Expe

nse

($)

Accelerated Depreciation

Years of Life

Annu

al

Depr

ecia

tion

Expe

nse

($)

L O 3

6-15

Depreciation Methods

Straight-Line Depreciation

Years of Life

Annu

al

Depr

ecia

tion

Expe

nse

($)

Straight-Line Methods

Straight-line

Units of production

L O 3

Accelerated Depreciation

Years of Life

Annu

al

Depr

ecia

tion

Expe

nse

($)

Accelerated Methods

Sum-of-the-years’-digits

Declining balance

6-16

EXAMPLE

On December 31, 2007, equipment was purchased for $50,000 cash. The equipment has an

estimated useful life of 5 years and an estimated residual value of $5,000.

SL

Straight-Line Method

Cost - Estimated Salvage ValueEstimated Useful Life

Annual DepreciationExpense =

L O 3

Formula

6-17

Annual DepreciationExpense

=

Annual DepreciationExpense

= $9,000

$50,000 - $5,0005 years

Straight-Line Method

SL

Cost - Estimated Salvage ValueEstimated Useful Life

Annual DepreciationExpense =

L O 3

6-18

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) Balance (NBV)2007 50,000$ 2008 9,000$ 9,000$ 9,000$ 41,000 2009 9,000 9,000 18,000 32,000 2010 9,000 9,000 27,000 23,000 2011 9,000 9,000 36,000 14,000 2012 9,000 9,000 45,000 5,000

45,000$ 45,000$ Salvage Value

Straight-Line Method

SL

L O 3

Depreciation stops when

NBV=SALVAGE VALUE

6-19

Dep

reci

atio

n Ex

pens

e

Depreciation Expense is reported on the Income

Statement.

Book Value is reported on the Balance Sheet.

SL

L O 3 Straight-Line Method

6-20

Step 2:

Annual Depreciation Expense =

DepreciationExpense Per Unit

Produced×

Number of Units Produced

during the Year

Units-of-Production Method

DepreciationExpense Per Unit

Produced= Cost - Estimated Salvage Value

Estimated Total Units to be Made

Step 1:

L O 3

6-21

On December 31, 2007, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its

useful life and has an estimated salvage value of $5,000.

If 22,000 units were produced in 2008, what is the amount of depreciation expense?

Units-of-Production MethodL O 3

6-22

=

Units-of-Production Method

DepreciationExpense Per Unit

Produced $50,000 - $5,000

100,000

Step 1:

= $.45 per unit

L O 3

Step 2:

Annual Depreciation Expense = $.45 per unit × 22,000 $9,900=

6-23

Accumulated UndepreciatedDepreciation Depreciation Balance

Year Units Expense Balance (book value)2007 50,000$ 2008 22,000 9,900$ 9,900$ 40,100 2009 28,000 12,600 22,500 27,500 2010 * - - 22,500 27,500 2011 32,000 14,400 36,900 13,100 2012 18,000 8,100 45,000 5,000

100,000 45,000$

No depreciation expense is recorded if the equipment is idle.

Salvage Value

Units-of-Production MethodL O 3

6-24

Annual DepreciationExpense =

Double the Straight-line

Depreciation Rate× Book Value at

Beginning of Year

Declining-Balance Method

1

Life in Years× 2

Since we are using 2 times the

straight-line rate, this is called the

Double-Declining-Balance Method.

L O 3

6-25

On December 31, equipment was purchased for $50,000 cash. The

equipment has an estimated useful life of 5 years and an estimated residual

value of $5,000.

Calculate the depreciation expense for 2008 and 2009.

Declining-Balance MethodL O 3

6-26

Double the Straight-line Depreciation Rate2 × 20% = 40%

Depreciation Expense for 200840% × $50,000 = $20,000

Declining-Balance MethodL O 3

Depreciation Expense for 2009 40% × ($50,000 - $20,000) = $12,000

Net Book Value at Beginning of Year

6-27

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (NBV)2007 50,000$ 2008 20,000$ 20,000$ 30,000 2009 12,000 32,000 18,000 2010 7,200 39,200 10,800 2011 4,320 43,520 6,480 2012 2,592 46,112 3,888

46,112$

($50,000 – $43,520) × 40% = $2,592

Below salvage value

Declining-Balance MethodL O 3

6-28

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (NBV)2007 50,000$ 2008 20,000$ 20,000$ 30,000 2009 12,000 32,000 18,000 2010 7,200 39,200 10,800 2011 4,320 43,520 6,480 2012 1,480 45,000 5,000

45,000$

In the latter years, depreciation is limited to NBV X 40%, but the asset cannot be depreciated below salvage value.

Declining-Balance MethodL O 3

$1,480 = 6,480 – 5,000 salvage value

6-29

Life in Years

$0

$2,000

$4,000

$6,000

$8,000

$10,000

1 2 3 4 5

Ann

ual

Dep

reci

atio

n

Straight-Line

$0$2,000$4,000$6,000$8,000

$10,000$12,000$14,000$16,000

1 2 3 4 5Life in Years

Ann

ual

Dep

reci

atio

n

Units-of-Production

Life in Years

Ann

ual

Dep

reci

atio

n

$0

$5,000

$10,000

$15,000

$20,000

1 2 3 4 5

Double-Declining-Balance

Comparing Depreciation MethodsL O 3

Total Depreciation at end of useful life will be the same regardless of Depreciation method

6-30

Depreciation Methods Used by 670 Companies

586

32

22

16

8

6

Straight-line

Accelerated method-notspecifiedUnits of production

Declining-balance

Other

Sum-of-the-years'digits

Source: Accounting Trends and Techniques, 2005, AICPA.

L O 3

6-31

Most corporations use the Modified Accelerated Cost Recovery System

(MACRS) for tax purposes.

MACRS depreciation provides for rapid write-off of an asset’s cost in order to

stimulate new investment.

Depreciation for Tax ReportingL O 4

Salvage values are ignoredUseful lives are set by the Internal Revenue Service

6-32

Maintenance and Repair Expense

Preventative maintenance

expenditures and routine repair costs are clearly expenses

of the period in which they are

incurred.

L O 5

6-33

Recording cashreceived (debit).

Removing accumulateddepreciation (debit).

Update depreciation to the date of disposal.

Journalize disposal by:

Removing the asset cost (credit).

Recording again (credit)

or loss (debit).

Disposal of Depreciable AssetsL O 6

6-34

•Cash > BV, record a gain (credit).•Cash < BV, record a loss (debit).•Cash = BV, no gain or loss.

Disposal of Depreciable Assets

Recording again (credit)

or loss (debit).

L O 6

Determining Gain or Loss

6-35

Selling Plant Assets

On 9/30/2008, Evans Company sells a machine

Date purchased 1/1/2003Cost $100,000

Depreciation Method Straight Line

Salvage Value $20,000

Estimated Useful Life 10 years

Selling price $60,000

L O 6

6-36

The amount of depreciation recorded on September 30, 2008,

to bring depreciation up to date is:

a. $8,000.b. $6,000.c. $4,000.d. $2,000.

Selling Plant AssetsL O 6

6-37

The amount of depreciation recorded on September 30, 2008,

to bring depreciation up to date is:

a. $8,000.b. $6,000.c. $4,000.d. $2,000.

Annual Depreciation:($100,000 - $20,000) ÷ 10 Yrs. = $8,000

Depreciation to Sept. 30:9/12 × $8,000 = $6,000

Selling Plant AssetsL O 6

6-38

After updating the depreciation, the machine’s net book value on

September 30, 2008, is:

a. $54,000.b. $46,000.c. $40,000.d. $60,000.

Selling Plant AssetsL O 6

6-39

After updating the depreciation, the machine’s book value on September 30, 2008, is:

a. $54,000.b. $46,000.c. $40,000.d. $60,000.

Cost 100,000$ Accumulated Depreciation: (5 yrs. × $8,000) + $6,000 = 46,000 Book Value 54,000$

Selling Plant AssetsL O 6

6-40

The machine’s sale resulted in:

a. a gain of $6,000.b. a gain of $4,000.c. a loss of $6,000.d. a loss of $4,000.

Selling Plant AssetsL O 6

6-41

The machine’s sale resulted in:

a. a gain of $6,000.b. a gain of $4,000.c. a loss of $6,000.d. a loss of $4,000.

Cost 100,000$ Accum. Depr. 46,000 Book Value 54,000 Cash Received 60,000 Gain 6,000$

Now, you are ready to prepare the journal entry to record the sale of the asset.

Selling Plant AssetsL O 6

6-42

Date Description Debit CreditSept 30 Cash 60,000

Accumulated Depreciation 46,000Gain on Sale 6,000Machine 100,000

Selling Plant AssetsL O 6

6-43

An operating lease is an

ordinary lease for the use of an asset that does not involve any

attributes of ownership.

A capital lease results in the

lessee (renter) assuming

virtually all of the benefits and

risks of ownership for

the leased asset.

Assets Acquired by Capital LeaseL O 7

6-44

*Capital Lease Characteristics:1. Transfers ownership to lessee.2. Includes nominal purchase price.3. Lease term is 75% of life of asset.4. Present value of lease payments is 90% of fair value of

asset.

Assets Acquired by Capital LeaseL O 7

Only 1 criteria needs to be met!

6-45

Computer equipment Cost: $217,765 Issue a 10%, 6 year Note Payable Annual payment: $50,000.

Computer Equipment Annual payment: $50,000. Present Value of Lease Payments: $50,000 @ 10%, 6 years = $217,765

Buy or Lease ?

Buy or Lease an Asset?

LeaseBuy

L O 8

6-46

Buy or Lease an Asset?

Buy

Lease

= Liabilities + Owners' Equity

Net income = Revenues - Expenses

1. Date of Acquisition Computer Equipment

Capital Lease Liability

+217,765 +217,7652. Annual Depreciation

Accumulated Depreciation

Depreciation Expense

3. Annual Lease Payment -Lease Liability Interest Expense

Balance Sheet Income Statement

Assets

= Liabilities + Owners' Equity

Net income = Revenues - Expenses

1. Date of Acquisition Computer Equipment

Note Payable

+217,765 +217,7652. Annual Depreciation

Accumulated Depreciation

Depreciation Expense

3. Annual Lease Payment -Note Principal Interest Expense

Balance Sheet Income Statement

Assets

L O 8

Leasing the computer is essentially the same as buying it. Both methods of acquiring the asset yield the same economic impact and the same effect on the financial statements.

6-47

IntangibleAssets

Intangible AssetsL O 9

Noncurrent assetswithout physical

substance.

Often provideexclusive rights

or privileges.

Useful life isoften difficultto determine.

Usually acquired for operational

use.

6-48

Patents Copyrights Leaseholds Leasehold

Improvements Franchises and

Licenses Trademarks and

Trade Names Goodwill

Record at current cash

equivalent cost, including

purchase price, legal fees, and

filing fees.

Intangible AssetsL O 9

6-49

Amortization for these intangibles: Patent = 20 years Registered Trademark = Unlimited life Copyright = Life of artist + 70 years

Use straight-line method. Amortize over legal life or useful life, whichever is less

Intangible Assets

Amortization is the term used to refer to the allocation of the cost of an intangible asset over

its useful life. The process is similar to straight-line depreciation.

L O 9

6-50

Occurs when onecompany buys

another company.

The amount by which thepurchase price exceeds the fair

market value of net assets acquired.

Goodwill

Only ‘purchased’ goodwill is an

intangible asset.

GoodwillL O 9

6-51

Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed liabilities of $200,000. The acquired assets were appraised

at a fair value of $900,000.

GoodwillL O 9

6-52

What amount of goodwill should be recorded on Eddy Company’s books?

a. $100,000.b. $200,000.c. $300,000.d. $400,000.

GoodwillL O 9

6-53

What amount of goodwill should be recorded on Eddy Company’s books?

a. $100,000b. $200,000c. $300,000d. $400,000

FMV of Assets 900,000$ Debt Assumed 200,000 FMV of Net Assets 700,000$ Purchase Price 1,000,000 Goodwill 300,000$

GoodwillL O 9

6-54

Goodwill

Recently, the FASB issued a non-

amortization approach to account for purchased

goodwill.

Under the impairment approach, goodwill will only be amortized when the initial recorded value

of the asset has deteriorated.

L O 9

6-55

Total cost,including

exploration anddevelopment,is charged to

depletion expenseover periods

benefited.

Examples: oil, coal, gold

Extracted fromthe natural

environmentand reportedat cost less

accumulateddepletion.

Natural ResourcesL O 9

6-56

Natural Resources

Depletion is the term used to refer to the

allocation of the cost of a natural resource over its useful life.

The process is similar to units-of-production

depreciation.

L O 9

6-57

Other Noncurrent Assets

Long-term Investments

Notes Receivables (with maturities more than a year after the balance

sheet date)

Long-term Deferred Income Tax Assets

When these assets become current, they will be reclassified to current assets.

L O 9

6-58

Time Value of Money

Present Value: the value now of an amountto be received or paid at some future date.

Future Value: the value at some future date of an investment made today.

L O 10

Today 1 year 2 years 3 years 4 years

$ 1,000 Invested at 10% has a future value of

$ 1,464

Today 1 year 2 years 3 years 4 years

$ 1,000 Is the present value at 10% of

$ 1,464

6-59

End of Chapter 6