Chapter 9: Long-Term Assets

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Long-Term Assets

-have future economic benefits for a firm for more than one year

-examples: plants assets and intangible assets

Examples of Plant Assets

property, plant, and equipment (land, building, machinery, airplanes, etc.)

Cost of Plant Assets [Part l]

-have PHYSICAL SUBSTANCE
-used in the operations of a business
-not intended for sale to customers
-deliver service potential over their useful lives (except land)
-recorded AT COST

Cost of Plant Assets [Part ll]

cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use

Cost of Plant Assets - Equipment

cost of equipment includes:
1. purchase price
2. sales tax
3. freight charges and insurance during transit
4. expenditures required in assembling
5. installing and testing the unit

Depreciation

process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner

TRUE

Long-term assets are depreciated over time, NOT expensed in the current period.

TRUE; does not measure the change in an asset's fair value during ownership, yet it reassigns the value

Depreciation is a cost allocation NOT a valuation process.

TRUE

Land is NOT depreciated since its usefulness and revenue producing ability generally remain intact, or increase.

Journal Entry of Depreciation

1) depreciation expense
2) accumulated depreciation (total amount of asset's cost charged to date)

-debit 'Depreciation Expense' and credit 'Accumulated Depreciation'

Factors in Computing Depreciation

1. Cost: all expenditures necessary to acquire the asset and make it ready for intended use
2. Useful Life: estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence [expressed in terms of time, units of activity (machine hours), or units of output]
3. Salvage Value: estimate of the asset's value at the end of its useful life

Depreciation Methods

1. Straight-Line
2. Declining Balance
3. Units of Activity

Straight-Line Depreciation

-used by more than 95% of U.S. companies (easy to compute partial year)

-expenses an equal amount of depreciation each year of the asset's useful life (constant)

- partial year may be taken in acquisition year

-ANNUAL DEPRECIATION EXPENSE

Annual Depreciation Expense [Straight-Line]

= (Cost of the Plant Asset - Salvage Value) / (Useful LIfe)

Declining-Balance Method

-computes periodic depreciation using a declining book value

-TWO STEPS: 1) determine rate of depreciation 2) annual depreciation expense

-considered to be an accelerated depreciation method [result in more depreciation in the early years of an asset's life and less depreciation in the later years]

-assumes greater benefits consumed in early years

-stop depreciating when salvage value is reached, otherwise ignore salvage value

Rates of Depreciation [Declining-Balance]

1. Double Declining-Balance Rate: (1/useful life) x 2

2. 150 % Declining-Balance Rate: (1/useful life) x 1.5

Annual Depreciation Expense [Declining-Balnce]

= (remaining net book value) x (rate)

Units-of-Activity Method

-useful life is expressed in terms of total units of production or the use expected from the asset

-ideally suited for factory machinery ... not buildings or furniture (companies can measure production in terms of units of output or in terms of machine hours)

-TWO STEPS: 1) Depreciation Rate 2) Depreciation Expense

Depreciation Rate [Units-of-Activity]

= (Cost of Plant Asset - Salvage Value) / (Est. Total Units Produced)

Depreciation Expense [Units-of-Activity]

= (Depreciation Rate) x (Actual Number of Units Produced for the Year)

TRUE

Periodic depreciation varies considerably among the methods, but total depreciation is the same for the five-year period.

Plant Assets Disposal

1. Sale: equipment is sold to another party
2. Retirement: equipment is scrapped and discarded
3. Exchange: existing equipment is traded for new equipment

Sale of Asset

PROCESS:
1. Update depreciation to date of disposal
2. Compute the gain or loss on disposition
3. Eliminate balance in asset

Gain/Loss on Disposition [Sale]

if the proceeds from the sale exceed or are less than the book value of the plant asset sold

**note that there are different journal entries for the gain and loss on disposition

Retirement of Plant Assets

RECORDED BY:
1. decreasing Accumulated Depreciation for the full amount of depreciation taken over the life of the asset
2. decreasing the asset account for the original cost of the asset

Gain/Loss on Disposition [Retirement]

-the loss is equal to the asset's book value at the time of retirement
-the gain is not possible
-decrease (debit) accumulated depreciation and decrease (credit) account for original cost of the asset

Return on Assets Ratio

= *(net income) / (average total assets)*

-indicates the amount of net income generated by each dollar invested in assets [higher, the more efficient]

Asset Turnover Ratio

= (net sales) / (average total assets)

-indicaties (1) how efficiently a company uses its assets and (2) how many dollars of sales are generated by each dollar invested in assets [higher the better]

Profit Margin

= (net income) / (net sales)

Intangible Assets

-rights, privileges, or competitive advantages
-recorded at cost
-DO NOT possess physical substance
-often most valuable asset of a company
- ex) patents, copyrights, trademark, or goodwill

Goodwill

-the value of all favorable attributes that relate to a company that are not attributable to any other specific asset

-companies record goodwill only when there is an exchange transaction that involves the purchase of an entire business; when an entire business is purchased, goodwill is the excess of cost over the fair value of the nets assets acquired

EX) exceptional management, desirable location, good customer relations, skilled employees, high-quality products, fair policies

amortization

the process of allocating/assigning to expense the cost of intangibles

TRUE

Costs of intangible assets with indefinite lives should NOT be amortized.

TRUE; examples of assets with a limited life are patents and copyrights

If the intangible asset has a limited useful life, its cost is amortized over the useful life.

TRUE

Goodwill is NOT amortized.

Patents

-exclusive right that by the US Patent Office that enables the recipient to manufacture, sell, or control an invention for a period of 20 years from the date of grant

-the initial cost of a patent is cash or cash equivalent price paid to acquire the patent

-legal costs of protecting a patent are added to the Patent account and amortized over the remaining life of the patent

Research and Development Costs

-payments that may lead to patents, copyrights, new processes, and new products

-usually expenses as incurred

TRUE

R&D costs are NOT intangible assets.

Financial Statement Presentation of Long-lived Assets

-plants assets are shown in the financial statements under PPE
-intangibles are shown separately under Intangible Assets

-CONTRA ASSETS: plant assets are a contra asset to 'Accumulated Depreciation'

-disclosures include major classes of assets and methods of depreciation

Accumulated Depreciation Cost [Straight-Line]

= annual depreciation cost x number of years

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