Ch.8Operating Assets:

Plant Assets,Natural Resources,

and Intangible Assets

Plant Assets,Natural Resources (FYI only)Intangible Assets (FYI only)

Part I: Plant Assets1. Acquisition of plant assets

2. Use and depreciation of plant assets

3. Repair and maintenance – post acquisition expenditures

4. Disposal of plant assets

(in millions)Land $ 179.5Buildings 813.6Machinery and equipment 1,608.6Leasehold improvements 470.2Construction in process 60.4

$ 3,132.3Less accumulated depreciation 1,545.4

Property, plant, and equipment (net) $ 1,586.9

Nike, Inc.Property, Plant, and Equipment

LO1

1. Acquisition Cost of Property, Plant, and Equipment

All of the costs necessary to acquire the asset and prepare it for its intended use

Purchaseprice

+Taxes Installation

costs

Transportation charges

LO2

Group Purchase

Allocate cost of lump-sum purchase based on fair market values

Cost$100,000

$75,000

$25,000

AllocatedCost

Land = $30,000

Building = $90,000

Fair MarketValue

75%

25%

% ofMarketValue

LO3

Capitalization of Interest

Interest can be included as part of the cost of an asset if the company:• Constructs the asset over time

and• Borrows money to finance

construction

LO 4

2. Depreciation of Property, Plant, and Equipment

Match cost ofassets

with periodsbenefited

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Straight Line Units ofProduction

Double Declining Balance

via

LO5

Straight-Line Method

Allocates the cost of the asset evenly over its useful life

Units-of-Production Method

Allocates the asset cost based on the number of units produced over its useful life

depreciation =

per unit

Double-Declining-Balance Method

Accelerated method – higher amount of depreciation in early years

Double the straight-line rate on a declining amount (book value)

Straight-linerate

Depreciation Example

On January 1, ExerCo purchases a

machine for $20,000. The life of the machine

is estimated at 5 years, after which it is

expected to be sold for $2,000.

Depreciation Example

Calculate ExerCo’s depreciation of the machine for years 1 through 5 using the straight-line, units-of-production and double-declining-balance depreciation methods.

$20,000 cost – $2,000 residual value = $18,000 to be depreciated

Straight-Line Depreciation

Depreciation = Cost – Residual Value Life

= $20,000 – $2,000 5 years

= $3,600

$18,0005-year life

$3,600Year 1

$3,600Year 2

$3,600Year 3

$3,600Year 4

$3,600Year 5

Units-of-Production Depreciation

ExerCo’s estimated machine production:

Year 1 3,600 unitsYear 2 3,600 unitsYear 3 3,600 unitsYear 4 3,600 unitsYear 5 3,600 unitsTotal 18,000 units

Units-of-Production Depreciation

Depreciation = Cost – Residual Value per unit Life in Units

= $20,000 – $2,000 18,000

= $1.00 per unit

ExerCo’s Depreciation in 2007:

4,000 Units × $1 per Unit = $ 4,000

Units-of-Production Depreciation

Double-Declining-Balance Depreciation

DDB Rate = (100%/Useful Life) × 2

= (100%/5 Years) × 2

= 40%

.40Initiallyignore

residual value

Double-Declining-Balance Depreciation

2007 Depreciation = Beginning Book Value × Rate

= $20,000 × 40%

= $8,000 Book Value at Book Value

atYear Rate Beginning of Year Depreciation End of Year

2007 40% $20,000 $8,000 $12,000

Double-Declining-Balance Depreciation

2008 Depreciation = Beginning Book Value × Rate

= $12,000 × 40%

= $4,800

Book Value at Book Value atYear Rate Beginning of Year Depreciation End of Year

2007 40% $20,000 $8,000 $12,000

2008 40 12,000 4,800 7,200

Double-Declining-Balance Depreciation

Book Value at Book Value at

Year Rate Beginning of Year Depreciation End of Year

2007 40% $20,000 $ 8,000 $12,0002008 40 12,000 4,800 7,200 2009 40 7,200 2,880 4,3202010 40 4,320 1,728 2,5922011 40 2,592 592 2,000

$18,000Final year’s depreciation = amount needed to equate book

value with salvage value= Residual

Value

Straight-Line vs. Double-Declining-Balance Depreciation

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

Year 1 Year 2 Year 3 Year 4 Year 5

Straight-Line

Double-Declining-Balance

Reasons for Choosing the Straight-Line Method

Simplicity Reporting to stockholders Comparability Bonus plans

Reasons for Choosing Accelerated Methods

Result in better matching of revenue and expenses for some assets, particularly those becoming obsolete quickly.

Minimize taxable income (but companies usually use one method for tax purpose and another for financial reporting purpose.

Part III: Repair and maintenance – post acquisition expenditures Such expenditures are charged to the period

incurred (referred to as revenue expenditure) unless they significant benefit future periods (referred to as capital expenditure).

Revenue expenditures Recorded as an expense when incurred:

Dr. repair/maintenance expense 100 Cr. Cash

100

Capital expenditures Such expenditures benefit future periods

Improve efficiency/productivity Extend useful life

They are added to the cost of the assets and depreciated over the remaining life of the assets

Dr. Plant asset/Accu. Depreciation 5,000

Cr. Cash 5,000

Capital vs. Revenue Expenditures

Category Example Asset or ExpenseNormal maintenance Repainting Expense

Minor repair Replace spark plugs Expense

Major repair Replace a vehicle’s

engine Asset*

Addition Add a wing to a

building Asset

*if life or productivity is enhanced

4. Disposal of Property, Plant, and Equipment

Record depreciation up to date of disposal Compute gain or loss on disposal

Selling Price > Book Value = Gain Selling Price < Book Value = Loss

LO8

Disposal of Property, Plant, and Equipment

Sell machine (cost $20,000; accumulated depreciation $9,000) for $12,400

Asset cost $20,000Less: Accumulated depreciation 9,000Book value $11,000Sale price 12,400

Gain on sale of asset $ 1,400

Example:

Part II: Natural Resources (FYI) Acquisition of natural resources is recorded at

cost When the natural resources are extracted, a

depletion expense is recorded

(in millions)

Weyerhauser CompanyPartial Balance Sheet

Property and equipment, net 11,843Construction in progress 269Investments in and advances to equity affiliates 489Goodwill 3,244

2004

Timber and timberlands at cost, less depletion charged to disposals 4,212

Natural Resources

Natural Resources

When a natural resource is used or consumed, it should be treated as an expense

Recording the expense is referred to as depletion

Depletion method is similar to the units-of-production method

Part III: Intangible Assets

Patents

Intangible Assets

Legal rights/privileges Long-term in nature Used in operation No physical properties

Goodwill

Trademarks

Copyrights

LO9

Acquisition of Intangible Assets

Acquisition of intangible assets is recorded at costExternally acquired: recorded at cost Internally developed

Only legal fees/registration fees are recorded as cost R&D costs are expensed when incurred

Amortization of Intangibles

Normally recorded using the straight-line method

Reported net of accumulated amortization Amortized over the legal or useful life,

whichever is shorter

LO10

Amortization of Intangibles

Nike developed a patent for $10,000. The patent’s legal life is 20 years, but its anticipated useful life is 5 years.

Example:

Amortization of Intangibles

Nike’s annual amortization:

Patent approval costs $10,000

Divided by:

Lesser of legal or useful life 5 years

Annual amortization $ 2,000

Journal entry:

Patent Amortization Expense 2,000

Accumulated Amortization—Patent 2,000To record amortization of patent for one year.