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9
Plant Assets, Natural
Resources, and
Intangible Assets
Chapter
STUDY
OBJECTIVES
After studying this chapter, you should be
able to:
1 Describe how the cost principle applies
to plant assets.
2 Explain the concept of depreciation.
3 Compute periodic depreciation using
different methods.
4 Describe the procedure for revising
periodic depreciation.
5 Distinguish between revenue and
capital expenditures, and explain the
entries for each.
6 Explain how to account for the disposal
of a plant asset.
7 Compute periodic depletion of natural
resources.
8 Explain the basic issues related to
accounting for intangible assets.
9 Indicate how plant assets, natural
resources, and intangible assets are
The Navigator
reported.
✓ The Navigator
Scan Study Objectives
■
Read Feature Story
■
Read Preview
■
Read text and answer
p. 402
■
p. 409
■
Work Comprehensive
Do it!
p. 412
Do it!
■
p. 417
p. 421
p. 422
■
■
■
Review Summary of Study Objectives
■
Answer Self-Study Questions
■
Complete Assignments
■
✓
Feature Story
HOW MUCH FOR A RIDE TO THE BEACH?
It’s spring break. Your plane has landed, you’ve finally found your bags, and
you’re dying to hit the beach—but first you need a “vehicular unit” to get
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you there. As you turn
away from baggage claim
you see a long row of
rental agency booths.
Many are names you are
familiar with—Hertz, Avis,
and Budget. But a booth
at the far end catches your
eye—Rent-A-Wreck
(www.rent-a-wreck.com).
Now there’s a company
making a clear statement!
Any company that relies
on equipment to generate
revenues must make decisions about what kind of equipment to buy, how
long to keep it, and how vigorously to maintain it. Rent-A-Wreck has decided
to rent used rather than new cars and trucks. It rents these vehicles across
the United States, Europe, and Asia. While the big-name agencies push
vehicles with that “new car smell,” Rent-A-Wreck competes on price. The
message is simple: Rent a used car and save some cash. It’s not a message
that appeals to everyone. If you’re a marketing executive wanting to impress
a big client, you probably don’t want to pull up in a Rent-A-Wreck car. But if
you want to get from point A to point B for the minimum cash per mile, then
they are playing your tune. The company’s message seems to be getting
across to the right clientele. Revenues have increased significantly.
When you rent a car from Rent-A-Wreck, you are renting from an independent business person who has paid a “franchise fee” for the right to use the
Rent-A-Wreck name. In order to gain a franchise, he or she must meet financial and other criteria, and must agree to run the rental agency according to
rules prescribed by Rent-A-Wreck. Some of these rules require that each franchise maintain its cars in a reasonable fashion. This ensures that, though you
won’t be cruising down Daytona Beach’s Atlantic Avenue in a Mercedes convertible, you can be reasonably assured that you won’t be calling a towtruck.
✓
The Navigator
Inside Chapter 9…
• Many U.S. Firms Use Leases
(p. 401)
• ESPN Wins Monday Night Football Franchise
(p. 416)
• All About You: Buying a Wreck of Your Own
(p. 420)
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Preview of Chapter 9
The accounting for long-term assets has important implications for a company’s reported results. In this
chapter, we explain the application of the cost principle of accounting to property, plant, and equipment, such
as Rent-A-Wreck vehicles, as well as to natural resources and intangible assets such as the “Rent-A-Wreck”
trademark. We also describe the methods that companies may use to allocate an asset’s cost over its useful
life. In addition, we discuss the accounting for expenditures incurred during the useful life of assets, such as
the cost of replacing tires and brake pads on rental cars.
The content and organization of Chapter 9 are as follows.
Plant Assets, Natural Resources, and Intangible Assets
Plant Assets
• Determining the cost
of plant assets
• Depreciation
• Expenditures during
useful life
• Plant asset disposals
Natural Resources
• Accounting for natural
resources
• Financial statement
presentation
Intangible Assets
• Accounting for intangibles
• Types of intangibles
• Research and
development costs
Statement Presentation
and Analysis
• Presentation
• Analysis
✓
SECTION 1
The Navigator
Plant Assets
Plant assets are resources that have three characteristics: they have a physical substance (a definite size and shape), are used in the operations of a business, and are
not intended for sale to customers. They are also called property, plant, and equipment; plant and equipment; and fixed assets. These assets are expected to provide
services to the company for a number of years. Except for land, plant assets decline
in service potential over their useful lives.
Because plant assets play a key role in ongoing operations, companies keep
plant assets in good operating condition. They also replace worn-out or outdated
plant assets, and expand productive resources as needed. Many companies have
substantial investments in plant assets. Illustration 9-1 shows the percentages of
plant assets in relation to total assets of companies in a number of industries.
Illustration 9-1
Percentages of plant assets
in relation to total assets
Southwest Airlines
75%
Wendy's
70%
Wal-Mart
56%
Nordstrom
36%
Caterpillar
Microsoft Corporation
18%
7%
10 20 30 40 50 60 70 80 90
Plant assets as a percentage of total assets
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Determining the Cost of Plant Assets
399
DETERMINING THE COST OF PLANT ASSETS
The cost principle requires that companies record plant assets at cost. Thus
STUDY OBJECTIVE 1
Rent-A-Wreck records its vehicles at cost. Cost consists of all expendi- Describe how the cost principle
tures necessary to acquire the asset and make it ready for its intended use. applies to plant assets.
For example, the cost of factory machinery includes the purchase price,
freight costs paid by the purchaser, and installation costs. Once cost is established,
the company uses that amount as the basis of accounting for the plant asset over its
useful life.
In the following sections, we explain the application of the cost principle to
each of the major classes of plant assets.
Land
Companies acquire land for use as a site upon which to build a manufacturing plant
or office.The cost of land includes (1) the cash purchase price, (2) closing costs such
as title and attorney’s fees, (3) real estate brokers’ commissions, and (4) accrued
property taxes and other liens assumed by the purchaser. For example, if the cash
price is $50,000 and the purchaser agrees to pay accrued taxes of $5,000, the cost of
the land is $55,000.
Companies record as debits (increases) to the Land account all necessary costs
incurred to make land ready for its intended use. When a company acquires vacant
land, these costs include expenditures for clearing, draining, filling, and grading.
Sometimes the land has a building on it that must be removed before construction
of a new building. In this case, the company debits to the Land account all demolition and removal costs, less any proceeds from salvaged materials.
To illustrate, assume that Hayes Manufacturing Company acquires real estate at a cash cost of $100,000. The property contains an old warehouse that is
razed at a net cost of $6,000 ($7,500 in costs less $1,500 proceeds from salvaged
materials). Additional expenditures are the attorney’s fee, $1,000, and the real estate broker’s commission, $8,000. The cost of the land is $115,000, computed as
follows.
HELPFUL HINT
Management’s intended
use is important in
applying the cost
principle.
Illustration 9-2
Computation of cost of land
Land
Cash price of property
Net removal cost of warehouse
Attorney’s fee
Real estate broker’s commission
$100,000
6,000
1,000
8,000
Cost of land
$115,000
When Hayes records the acquisition, it debits Land for $115,000 and credits Cash
for $115,000.
Land Improvements
Land improvements are structural additions made to land. Examples are driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of
land improvements includes all expenditures necessary to make the improvements
ready for their intended use. For example, the cost of a new parking lot for Home Depot
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
includes the amount paid for paving, fencing, and lighting. Thus Home Depot
debits to Land Improvements the total of all of these costs.
Land improvements have limited useful lives, and their maintenance and
replacement are the responsibility of the company. Because of their limited useful
life, companies expense (depreciate) the cost of land improvements over their useful lives.
Buildings
Buildings are facilities used in operations, such as stores, offices, factories, warehouses, and airplane hangars. Companies debit to the Buildings account all necessary expenditures related to the purchase or construction of a building. When a
building is purchased, such costs include the purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s commission. Costs to make
the building ready for its intended use include expenditures for remodeling and
replacing or repairing the roof, floors, electrical wiring, and plumbing. When a new
building is constructed, cost consists of the contract price plus payments for architects’
fees, building permits, and excavation costs.
In addition, companies charge certain interest costs to the Buildings
account: Interest costs incurred to finance the project are included in the cost of
the building when a significant period of time is required to get the building
ready for use. In these circumstances, interest costs are considered as necessary
as materials and labor. However, the inclusion of interest costs in the cost of a
constructed building is limited to the construction period. When construction
has been completed, the company records subsequent interest payments on
funds borrowed to finance the construction as debits (increases) to Interest
Expense.
Equipment
Equipment includes assets used in operations, such as store check-out counters,
office furniture, factory machinery, delivery trucks, and airplanes.The cost of equipment, such as Rent-A-Wreck vehicles, consists of the cash purchase price, sales
taxes, freight charges, and insurance during transit paid by the purchaser. It also
includes expenditures required in assembling, installing, and testing the unit.
However, Rent-A-Wreck does not include motor vehicle licenses and accident
insurance on company vehicles in the cost of equipment. These costs represent
annual recurring expenditures and do not benefit future periods. Thus, they are
treated as expenses as they are incurred.
To illustrate, assume Merten Company purchases factory machinery at a cash
price of $50,000. Related expenditures are for sales taxes $3,000, insurance during
shipping $500, and installation and testing $1,000. The cost of the factory machinery
is $54,500, computed as follows.
Illustration 9-3
Computation of cost of
factory machinery
Factory Machinery
Cash price
Sales taxes
Insurance during shipping
Installation and testing
$50,000
3,000
500
1,000
Cost of factory machinery
$54,500
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Determining the Cost of Plant Assets
Merten makes the following summary entry to record the purchase and related
expenditures:
Factory Machinery
Cash
(To record purchase of factory machine)
54,500
54,500
L
SE
54,500
54,500
Cash Flows
For another example, assume that Lenard Company purchases a delivery
truck at a cash price of $22,000. Related expenditures consist of sales taxes
$1,320, painting and lettering $500, motor vehicle license $80, and a three-year
accident insurance policy $1,600. The cost of the delivery truck is $23,820, computed as follows.
Cash price
Sales taxes
Painting and lettering
$22,000
1,320
500
Cost of delivery truck
$23,820
54,500
Illustration 9-4
Computation of cost of
delivery truck
Delivery Truck
Lenard treats the cost of the motor vehicle license as an expense, and the cost
of the insurance policy as a prepaid asset. Thus, Lenard makes the following entry
to record the purchase of the truck and related expenditures:
Delivery Truck
License Expense
Prepaid Insurance
Cash
(To record purchase of delivery truck and related
expenditures)
A
A
L
SE
23,820
23,820
80
1,600
80 Exp
25,500
ACCOUNTING ACROSS THE ORGANIZATION
Many U.S. Firms Use Leases
Leasing is big business for U.S. companies. For example, business investment in
equipment in a recent year totaled $709 billion. Leasing accounted for about
31% of all business investment ($218 billion).
Who does the most leasing? Interestingly major banks, such as Continental Bank, J.P.
Morgan Leasing, and US Bancorp Equipment Finance, are the major lessors. Also, many companies have established separate leasing companies, such as Boeing Capital Corporation,
Dell Financial Services, and John Deere Capital Corporation. And, as an excellent example of
the magnitude of leasing, leased planes account for nearly 40% of the U.S. fleet of commercial airlines. In addition, leasing is becoming increasingly common in the hotel industry.
Marriott, Hilton, and InterContinental are increasingly choosing to lease hotels that are owned
by someone else.
Why might airline managers choose to lease rather than purchase their planes?
1,600
25,500
Cash Flows
25,500
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
before you go on...
Cost of Plant Assets
Action Plan
• Identify expenditures made in
order to get delivery equipment
ready for its intended use.
• Treat operating costs as
expenses.
Do it!
Assume that Drummond Heating and Cooling Co. purchases a delivery truck
for $15,000 cash, plus sales taxes of $900 and delivery costs of $500. The buyer also pays $200 for
painting and lettering, $600 for an annual insurance policy, and $80 for a motor vehicle license.
Explain how each of these costs would be accounted for.
Solution
The first four payments ($15,000, $900, $500, and $200) are expenditures necessary to make the
truck ready for its intended use. Thus, the cost of the truck is $16,600. The payments for insurance
and the license are operating costs and therefore are expensed.
Related exercise material: BE9-1, BE9-2, E9-1, E9-2, E9-3, and Do it! 9-1.
✓
The Navigator
DEPRECIATION
STUDY OBJECTIVE 2
Explain the concept of
depreciation.
As explained in Chapter 3, depreciation is the process of allocating to
expense the cost of a plant asset over its useful (service) life in a rational
and systematic manner. Cost allocation enables companies to properly
match expenses with revenues in accordance with the expense recognition
principle (see Illustration 9-5).
Illustration 9-5
Depreciation as a cost
allocation concept
Depreciation
allocation
Year Year Year
1
2
3
Year Year Year
4
5
6
It is important to understand that depreciation is a process of cost allocation.
It is not a process of asset valuation. No attempt is made to measure the change in
an asset’s market value during ownership. So, the book value (cost less accumulated depreciation) of a plant asset may be quite different from its market value.
Depreciation applies to three classes of plant assets: land improvements, buildings, and equipment. Each asset in these classes is considered to be a depreciable
asset. Why? Because the usefulness to the company and revenue-producing ability
of each asset will decline over the asset’s useful life. Depreciation does not apply
to land because its usefulness and revenue-producing ability generally
remain intact over time. In fact, in many cases, the usefulness of land is
ETHICS NOTE
greater over time because of the scarcity of good land sites. Thus, land is
When a business is
not a depreciable asset.
acquired, proper allocation of
During a depreciable asset’s useful life, its revenue-producing ability
the purchase price to various
asset classes is important, since
declines because of wear and tear. A delivery truck that has been driven
different depreciation treatment
100,000 miles will be less useful to a company than one driven only 800 miles.
can materially affect income.
Revenue-producing ability may also decline because of obsolescence.
For example, buildings are
Obsolescence is the process of becoming out of date before the asset physdepreciated, but land is not.
ically wears out. For example, major airlines moved from Chicago’s
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Depreciation
403
Midway Airport to Chicago-O’Hare International Airport because Midway’s
runways were too short for jumbo jets. Similarly, many companies replace their
computers long before they originally planned to do so because improvements in
new computing technology make the old computers obsolete.
Recognizing depreciation on an asset does not result in an accumulation of
cash for replacement of the asset. The balance in Accumulated Depreciation represents the total amount of the asset’s cost that the company has charged to expense.
It is not a cash fund.
Note that the concept of depreciation is consistent with the going-concern assumption. The going-concern assumption states that the company will continue in
operation for the foreseeable future. If a company does not use a going-concern
assumption, then plant assets should be stated at their market value. In that case,
depreciation of these assets is not needed.
Factors in Computing Depreciation
Three factors affect the computation of depreciation:
1. Cost. Earlier, we explained the issues affecting the cost of a depreciable asset.
Recall that companies record plant assets at cost, in accordance with the cost
principle.
2. Useful life. Useful life is an estimate of the expected productive life, also called
service life, of the asset. Useful life may be expressed in terms of time, units of
activity (such as machine hours), or units of output. Useful life is an estimate.
In making the estimate, management considers such factors as the intended use
of the asset, its expected repair and maintenance, and its vulnerability to obsolescence. Past experience with similar assets is often helpful in deciding on expected useful life. We might reasonably expect Rent-A-Wreck and Avis to use
different estimated useful lives for their vehicles.
3. Salvage value. Salvage value is an estimate of the asset’s value at the end of its
useful life. This value may be based on the asset’s worth as scrap or on its
expected trade-in value. Like useful life, salvage value is an estimate. In making
the estimate, management considers how it plans to dispose of the asset and its
experience with similar assets.
Illustration 9-6 summarizes the three factors used in computing depreciation.
A LT E R N AT I V E
TERMINOLOGY
Another term sometimes
used for salvage value is
residual value.
Illustration 9-6
Three factors in computing
depreciation
Cost: all expenditures
necessary to acquire
the asset and make it
ready for intended use
Useful life: estimate of the
expected life based on need
for repair, service life, and
vulnerability to obsolescence
Salvage value: estimate of
,
the asset s value at the end
of its useful life
HELPFUL HINT
Depreciation expense is
reported on the income
statement. Accumulated
depreciation is reported
on the balance sheet as
a deduction from plant
assets.
Depreciation Methods
Depreciation is generally computed using one of the following methods:
1. Straight-line
2. Units-of-activity
3. Declining-balance
STUDY OBJECTIVE 3
Compute periodic depreciation
using different methods.
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Each method is acceptable under generally accepted accounting principles.
Management selects the method(s) it believes to be appropriate. The objective
is to select the method that best measures an asset’s contribution to revenue
over its useful life. Once a company chooses a method, it should apply it
consistently over the useful life of the asset. Consistency enhances the comparability of financial statements. Depreciation affects the balance sheet through
accumulated depreciation and the income statement through depreciation
expense.
We will compare the three depreciation methods using the following data for a
small delivery truck purchased by Barb’s Florists on January 1, 2011.
Illustration 9-7
Delivery truck data
Cost
Expected salvage value
Estimated useful life in years
Estimated useful life in miles
$13,000
$ 1,000
5
100,000
Illustration 9-8 (in the margin) shows the use of the primary depreciation
methods in 600 of the largest companies in the United States.
88%
Straight-line
2% Declining-balance
3% Units-of-activity
7% Other
Illustration 9-8
Use of depreciation
methods in 600 large U.S.
companies
Illustration 9-9
Formula for straight-line
method
STRAIGHT-LINE
Under the straight-line method, companies expense the same amount of depreciation for each year of the asset’s useful life. It is measured solely by the passage
of time.
In order to compute depreciation expense under the straight-line method,
companies need to determine depreciable cost. Depreciable cost is the cost of
the asset less its salvage value. It represents the total amount subject to depreciation. Under the straight-line method, to determine annual depreciation expense, we divide depreciable cost by the asset’s useful life. Illustration 9-9
shows the computation of the first year’s depreciation expense for Barb’s
Florists.
Cost
ⴚ
$13,000
Salvage
Value
$1,000
ⴝ
Depreciable
Cost
$12,000
Annual
Depreciable ⴜ Useful Life ⴝ Depreciation
Cost
(in years)
Expense
$12,000
5
$2,400
Alternatively, we also can compute an annual rate of depreciation. In this case,
the rate is 20% (100% 5 years). When a company uses an annual straight-line
rate, it applies the percentage rate to the depreciable cost of the asset.
Illustration 9-10 (page 405) shows a depreciation schedule using an annual rate.
This illustration indicates that the depreciation expense of $2,400 is the same each
year. The book value (computed as cost minus accumulated depreciation) at the
end of the useful life is equal to the expected $1,000 salvage value.
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Depreciation
$12,000
12,000
12,000
12,000
12,000
ⴝ
Accumulated
Depreciation
Book
Value
$2,400
2,400
2,400
2,400
2,400
$ 2,400
4,800
7,200
9,600
12,000
$10,600*
8,200
5,800
3,400
1,000
20%
20
20
20
20
*Book value Cost Accumulated depreciation ($13,000 $2,400).
$2,400
2013
2011
2012
2013
2014
2015
ⴛ
End of Year
Annual
Depreciation
Expense
2012
Year
Depreciation
Rate
2011
Computation
Depreciable
Cost
Illustration 9-10
Straight-line depreciation
schedule
Depreciation Expense
BARB’S FLORISTS
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Year
What happens to these computations for an asset purchased during the year,
rather than on January 1? In that case, it is necessary to prorate the annual depreciation on a time basis. If Barb’s Florists had purchased the delivery truck on
April 1, 2011, the company would own the truck for nine months of the first year
(April–December). Thus, depreciation for 2011 would be $1,800 ($12,000 20%
9/12 of a year).
The straight-line method predominates in practice. Such large companies as
Campbell Soup, Marriott, and General Mills use the straight-line method. It is
simple to apply, and it matches expenses with revenues when the use of the asset
is reasonably uniform throughout the service life. For simplicity, Rent-A-Wreck is
probably using the straight-line method of depreciation for its vehicles.
UNITS-OF-ACTIVITY
Under the units-of-activity method, useful life is expressed in terms of the total
units of production or use expected from the asset, rather than as a time period.
The units-of-activity method is ideally suited to factory machinery. Manufacturing
companies can measure production in units of output or in machine hours. This
method can also be used for such assets as delivery equipment (miles driven) and
airplanes (hours in use). The units-of-activity method is generally not suitable for
buildings or furniture, because depreciation for these assets is more a function of
time than of use.
To use this method, companies estimate the total units of activity for the entire
useful life, and then divide these units into depreciable cost.The resulting number represents the depreciation cost per unit.The depreciation cost per unit is then applied to
the units of activity during the year to determine the annual depreciation expense.
To illustrate, assume that Barb’s Florists drives its delivery truck 15,000 miles
in the first year. Illustration 9-11 shows the units-of-activity formula and the computation of the first year’s depreciation expense.
Depreciable
ⴜ
Cost
$12,000
Total Units
of Activity
100,000 miles
Depreciation
ⴝ
Cost per
Unit
$0.12
Depreciable
Units of
Annual
Cost per
ⴛ Activity during ⴝ Depreciation
Unit
the Year
Expense
$0.12
15,000 miles
$1,800
A LT E R N AT I V E
TERMINOLOGY
Another term often used
is the units-of-production
method.
HELPFUL HINT
Under any method,
depreciation stops when
the asset’s book value
equals expected salvage
value.
Illustration 9-11
Formula for units-of-activity
method
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The units-of-activity depreciation schedule, using assumed mileage, is as follows.
Year
BARB’S FLORISTS
2015
Computation
2014
2013
2012
$5,000
$4,000
$3,000
$2,000
$1,000
0
2011
Depreciation Expense
Illustration 9-12
Units-of-activity
depreciation schedule
Year
Units of
Activity
2011
2012
2013
2014
2015
15,000
30,000
20,000
25,000
10,000
ⴛ
Depreciation
Cost/Unit
$0.12
0.12
0.12
0.12
0.12
ⴝ
End of Year
Annual
Depreciation
Expense
Accumulated
Depreciation
Book
Value
$1,800
3,600
2,400
3,000
1,200
$ 1,800
5,400
7,800
10,800
12,000
$11,200*
7,600
5,200
2,200
1,000
*($13,000 $1,800).
This method is easy to apply for assets purchased mid-year. In such a case, the
company computes the depreciation using the productivity of the asset for the partial year.
The units-of-activity method is not nearly as popular as the straight-line
method (see Illustration 9-8, page 404), primarily because it is often difficult for
companies to reasonably estimate total activity. However, some very large
companies, such as Chevron and Boise Cascade (a forestry company), do use this
method. When the productivity of an asset varies significantly from one period to
another, the units-of-activity method results in the best matching of expenses
with revenues.
DECLINING-BALANCE
The declining-balance method produces a decreasing annual depreciation expense
over the asset’s useful life. The method is so named because the periodic depreciation is based on a declining book value (cost less accumulated depreciation) of the
asset. With this method, companies compute annual depreciation expense by multiplying the book value at the beginning of the year by the declining-balance depreciation rate. The depreciation rate remains constant from year to year, but the book
value to which the rate is applied declines each year.
At the beginning of the first year, book value is the cost of the asset. This is so
because the balance in accumulated depreciation at the beginning of the asset’s
useful life is zero. In subsequent years, book value is the difference between cost
and accumulated depreciation to date. Unlike the other depreciation methods, the
declining-balance method does not use depreciable cost. That is, it ignores salvage
value in determining the amount to which the declining-balance rate is applied.
Salvage value, however, does limit the total depreciation that can be taken.
Depreciation stops when the asset’s book value equals expected salvage value.
A common declining-balance rate is double the straight-line rate. The method
is often called the double-declining-balance method. If Barb’s Florists uses the
double-declining-balance method, it uses a depreciation rate of 40% (2 the
straight-line rate of 20%). Illustration 9-13 shows the declining-balance formula
and the computation of the first year’s depreciation on the delivery truck.
Illustration 9-13
Formula for decliningbalance method
Book Value
DecliningAnnual
at Beginning ⴛ Balance ⴝ Depreciation
of Year
Rate
Expense
$13,000
40%
$5,200
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Depreciation
407
The depreciation schedule under this method is as follows.
$5,200
3,120
1,872
1,123
685*
$ 5,200
8,320
10,192
11,315
12,000
$7,800
4,680
2,808
1,685
1,000
40%
40
40
40
40
*Computation of $674 ($1,685 40%) is adjusted to $685 in order for book value to equal salvage value.
$5,000
$4,000
$3,000
$2,000
$1,000
0
2015
Book
Value
2014
$13,000
7,800
4,680
2,808
1,685
ⴝ
Accumulated
Depreciation
2013
2011
2012
2013
2014
2015
ⴛ
End of Year
Annual
Depreciation
Expense
2012
Year
Depreciation
Rate
2011
Computation
Book Value
Beginning of Year
Illustration 9-14
Double-declining-balance
depreciation schedule
Depreciation Expense
BARB’S FLORISTS
Year
The delivery equipment is 69% depreciated ($8,320 $12,000) at the end of
the second year. Under the straight-line method, the truck would be depreciated
40% ($4,800 $12,000) at that time. Because the declining-balance method produces higher depreciation expense in the early years than in the later years, it is
considered an accelerated-depreciation method. The declining-balance method is
compatible with the expense recognition principle. It matches the higher depreciation expense in early years with the higher benefits received in these years. It also
recognizes lower depreciation expense in later years, when the asset’s contribution
to revenue is less. Some assets lose usefulness rapidly because of obsolescence. In
these cases, the declining-balance method provides the most appropriate depreciation amount.
When a company purchases an asset during the year, it must prorate the first
year’s declining-balance depreciation on a time basis. For example, if Barb’s
Florists had purchased the truck on April 1, 2011, depreciation for 2011 would become $3,900 ($13,000 40% 9/12). The book value at the beginning of 2012 is
then $9,100 ($13,000 $3,900), and the 2012 depreciation is $3,640 ($9,100
40%). Subsequent computations would follow from those amounts.
HELPFUL HINT
The method recommended for an asset that
is expected to be significantly more productive
in the first half of its
useful life is the decliningbalance method.
COMPARISON OF METHODS
Illustration 9-15 compares annual and total depreciation expense under each of the
three methods for Barb’s Florists.
Year
2011
2012
2013
2014
2015
StraightLine
$ 2,400
2,400
2,400
2,400
2,400
$12,000
Units-ofActivity
$ 1,800
3,600
2,400
3,000
1,200
$12,000
DecliningBalance
$ 5,200
3,120
1,872
1,123
685
$12,000
Annual depreciation varies considerably among the methods, but total depreciation is the same for the five-year period under all three methods. Each method
is acceptable in accounting, because each recognizes in a rational and systematic
manner the decline in service potential of the asset. Illustration 9-16 (page 408)
graphs the depreciation expense pattern under each method.
Illustration 9-15
Comparison of depreciation
methods
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Illustration 9-16
Patterns of depreciation
Depreciation Expense
Key:
Straight-line
Declining-balance
Units-of-activity
$5,000
$4,000
$3,000
$2,000
$1,000
0
2011 2012 2013 2014 2015
Year
Depreciation and Income Taxes
The Internal Revenue Service (IRS) allows corporate taxpayers to deduct depreciation expense when they compute taxable income. However, the IRS does not require the taxpayer to use the same depreciation method on the tax return that is
used in preparing financial statements.
Many corporations use straight-line in their financial statements to maximize
net income. At the same time, they use a special accelerated-depreciation method
on their tax returns to minimize their income taxes. Taxpayers must use on their tax
returns either the straight-line method or a special accelerated-depreciation
method called the Modified Accelerated Cost Recovery System (MACRS).
Revising Periodic Depreciation
Depreciation is one example of the use of estimation in the accounting
process. Management should periodically review annual depreciation
Describe the procedure for
expense. If wear and tear or obsolescence indicate that annual depreciarevising periodic depreciation.
tion estimates are inadequate or excessive, the company should change
the amount of depreciation expense.
When a change in an estimate is required, the company makes the change in
current and future years. It does not change depreciation in prior periods. The
rationale is that continual restatement of prior periods would adversely affect confidence in financial statements.
To determine the new annual depreciation expense, the company first comHELPFUL HINT
putes
the asset’s depreciable cost at the time of the revision. It then allocates the reUse a step-by-step
vised
depreciable
cost to the remaining useful life.
approach: (1) determine
To illustrate, assume that Barb’s Florists decides on January 1, 2014, to extend the
new depreciable cost;
(2) divide by remaining
useful life of the truck one year because of its excellent condition. The company has
useful life.
used the straight-line method to depreciate the asset to date, and book value is $5,800
($13,000 $7,200). The new annual depreciation is $1,600, computed as follows.
STUDY OBJECTIVE 4
Illustration 9-17
Revised depreciation
computation
Book value, 1/1/14
Less: Salvage value
$5,800
1,000
Depreciable cost
$4,800
Remaining useful life
3 years
Revised annual depreciation ($4,800 ⴜ 3)
$1,600
(2014–2016)
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Expenditures During Useful Life
409
Barb’s Florists makes no entry for the change in estimate. On December 31, 2014,
during the preparation of adjusting entries, it records depreciation expense of
$1,600. Companies must describe in the financial statements significant changes in
estimates.
before you go on...
Do it!
On January 1, 2011, Iron Mountain Ski Corporation purchased a new snowgrooming machine for $50,000. The machine is estimated to have a 10-year life with a $2,000
salvage value. What journal entry would Iron Mountain Ski Corporation make at December 31,
2011, if it uses the straight-line method of depreciation?
Solution
Depreciation expense
Cost Salvage value $50,000 $2,000
$4,800
Useful life
10
The entry to record the first year’s depreciation would be:
Dec. 31
Depreciation Expense
Accumulated Depreciation
(To record annual depreciation on snowgrooming machine)
Straight-Line Depreciation
Action Plan
• Calculate depreciable cost
(CostSalvage value).
• Divide the depreciable
cost by the estimated useful
life.
4,800
4,800
Related exercise material: BE9-3, BE9-4, BE9-5, BE9-6, BE9-7, E9-5, E9-6, E9-7, E9-8, and Do it! 9-2.
✓
The Navigator
EXPENDITURES DURING USEFUL LIFE
During the useful life of a plant asset, a company may incur costs for ordiSTUDY OBJECTIVE 5
nary repairs, additions, or improvements. Ordinary repairs are expendi- Distinguish between revenue and
tures to maintain the operating efficiency and productive life of the unit. capital expenditures, and explain
They usually are fairly small amounts that occur frequently. Examples are the entries for each.
motor tune-ups and oil changes, the painting of buildings, and the replacing of worn-out gears on machinery. Companies record such repairs as debits to
Repair (or Maintenance) Expense as they are incurred. Because they are immediately charged as an expense against revenues, these costs are often referred to as
revenue expenditures.
Additions and improvements are costs incurred to increase the operETHICS NOTE
ating efficiency, productive capacity, or useful life of a plant asset. They are
WorldCom
perpetrated
usually material in amount and occur infrequently. Additions and imthe largest accounting fraud in
provements increase the company’s investment in productive facilities.
history by treating $7 billion
Companies generally debit these amounts to the plant asset affected. They of “line costs” as capital
are often referred to as capital expenditures. Most major U.S. corporations expenditures. Line costs are
disclose annual capital expenditures.
rental payments to access other
Companies must use good judgment in deciding between a revenue ex- companies’ networks. Like any
penditure and capital expenditure. For example, assume that Rodriguez Co. other rental payment, they
purchases a number of wastepaper baskets.Although the proper accounting should have been expensed as
would appear to be to capitalize and then depreciate these wastepaper bas- incurred. Instead, capitalization
kets over their useful life, it would be more usual for Rodriguez to expense delayed expense recognition to
them immediately. This practice is justified on the basis of materiality. future periods and thus boosted
Materiality refers to the impact of an item’s size on a company’s financial current-period profits.
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
operations. The materiality principle states that if an item would not make a difference in decision making, the company does not have to follow GAAP in reporting
that item.
PLANT ASSET DISPOSALS
Companies dispose of plant assets in three ways—retirement, sale, or
exchange—as Illustration 9-18 shows. Whatever the method, at the time of
Explain how to account for the
disposal the company must determine the book value of the plant asset.
disposal of a plant asset.
As noted earlier, book value is the difference between the cost of a plant
asset and the accumulated depreciation to date.
STUDY OBJECTIVE 6
Piper
Co.
Lowy
Co.
Piper
Co.
Lowy
Co.
Retirement
Sale
Exchange
Equipment is scrapped
or discarded.
Equipment is sold
to another party.
Existing equipment is traded
for new equipment.
Illustration 9-18
Methods of plant asset
disposal
At the time of disposal, the company records depreciation for the fraction of
the year to the date of disposal. The book value is then eliminated by (1) debiting
(decreasing) Accumulated Depreciation for the total depreciation to date, and
(2) crediting (decreasing) the asset account for the cost of the asset. In this
chapter we examine the accounting for the retirement and sale of plant assets. In
the appendix to the chapter we discuss and illustrate the accounting for exchanges
of plant assets.
Retirement of Plant Assets
A
L
SE
32,000
32,000
Cash Flows
no effect
HELPFUL HINT
When a company
disposes of a plant
asset, the company
must remove from the
accounts all amounts
related to the asset. This
includes the original cost
in the asset account and
the total depreciation to
date in the accumulated
depreciation account.
To illustrate the retirement of plant assets, assume that Hobart Enterprises retires
its computer printers, which cost $32,000. The accumulated depreciation on these
printers is $32,000. The equipment, therefore, is fully depreciated (zero book
value). The entry to record this retirement is as follows.
Accumulated Depreciation—Printing Equipment
Printing Equipment
(To record retirement of fully depreciated equipment)
32,000
32,000
What happens if a fully depreciated plant asset is still useful to the company?
In this case, the asset and its accumulated depreciation continue to be reported on
the balance sheet, without further depreciation adjustment, until the company retires the asset. Reporting the asset and related accumulated depreciation on the
balance sheet informs the financial statement reader that the asset is still in use.
Once fully depreciated, no additional depreciation should be taken, even if an asset is still being used. In no situation can the accumulated depreciation on a plant
asset exceed its cost.
If a company retires a plant asset before it is fully depreciated, and no cash is
received for scrap or salvage value, a loss on disposal occurs. For example, assume
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Plant Asset Disposals
411
that Sunset Company discards delivery equipment that cost $18,000 and has accumulated depreciation of $14,000. The entry is as follows.
A
Accumulated Depreciation—Delivery Equipment
Loss on Disposal
Delivery Equipment
(To record retirement of delivery equipment at a loss)
L
SE
14,000
14,000
4,000
4,000 Exp
18,000
18,000
Cash Flows
no effect
Companies report a loss on disposal in the “Other expenses and losses” section of
the income statement.
Sale of Plant Assets
In a disposal by sale, the company compares the book value of the asset with the
proceeds received from the sale. If the proceeds of the sale exceed the book value
of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than
the book value of the plant asset sold, a loss on disposal occurs.
Only by coincidence will the book value and the fair market value of the asset be the same when the asset is sold. Gains and losses on sales of plant assets
are therefore quite common. For example, Delta Airlines reported a $94,343,000
gain on the sale of five Boeing B727-200 aircraft and five Lockheed L-1011-1
aircraft.
GAIN ON DISPOSAL
To illustrate a gain, assume that on July 1, 2011, Wright Company sells office furniture for $16,000 cash. The office furniture originally cost $60,000. As of January 1,
2011, it had accumulated depreciation of $41,000. Depreciation for the first six
months of 2011 is $8,000. Wright records depreciation expense and updates accumulated depreciation to July 1 with the following entry.
A
July 1
Depreciation Expense
Accumulated Depreciation—Office Furniture
(To record depreciation expense for the first
6 months of 2011)
L
SE
8,000 Exp
8,000
8,000
8,000
Cash Flows
no effect
After the accumulated depreciation balance is updated, the company computes the gain or loss. Illustration 9-19 shows this computation for Wright
Company, which has a gain on disposal of $5,000.
Cost of office furniture
Less: Accumulated depreciation ($41,000 $8,000)
Book value at date of disposal
Proceeds from sale
Gain on disposal
$60,000
49,000
11,000
16,000
$ 5,000
Illustration 9-19
Computation of gain on
disposal
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Wright records the sale and the gain on disposal as follows.
A
L
SE
July 1
16,000
49,000
60,000
5,000 Rev
Cash Flows
Cash
Accumulated Depreciation—Office Furniture
Office Furniture
Gain on Disposal
(To record sale of office furniture at a gain)
16,000
49,000
60,000
5,000
16,000
Companies report a gain on disposal in the “Other revenues and gains” section of
the income statement.
LOSS ON DISPOSAL
Assume that instead of selling the office furniture for $16,000, Wright sells it for
$9,000. In this case, Wright computes a loss of $2,000 as follows.
Illustration 9-20
Computation of loss on
disposal
Cost of office furniture
Less: Accumulated depreciation
Book value at date of disposal
Proceeds from sale
Loss on disposal
$60,000
49,000
11,000
9,000
$ 2,000
Wright records the sale and the loss on disposal as follows.
A
L
SE
July 1
9,000
49,000
2,000 Exp
60,000
Cash
Accumulated Depreciation—Office Furniture
Loss on Disposal
Office Furniture
(To record sale of office furniture at a loss)
9,000
49,000
2,000
60,000
Cash Flows
9,000
Companies report a loss on disposal in the “Other expenses and losses” section of
the income statement.
before you go on...
Plant Asset Disposal
Action Plan
• At the time of disposal,
determine the book value of
the asset.
• Compare the asset’s book value
with the proceeds received to
determine whether a gain or
loss has occurred.
Do it!
Overland Trucking has an old truck that cost $30,000, and it has accumulated
depreciation of $16,000 on this truck. Overland has decided to sell the truck. (a) What entry
would Overland Trucking make to record the sale of the truck for $17,000 cash? (b) What entry
would Overland Trucking make to record the sale of the truck for $10,000 cash?
Solution
(a) Sale of truck for cash at a gain:
Cash
Accumulated Depreciation—Truck
Truck
Gain on Disposal [$17,000 ($30,000 $16,000)]
(To record sale of truck at a gain)
17,000
16,000
30,000
3,000
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Accounting for Natural Resources
(b) Sale of truck for cash at a loss:
Cash
Loss on Disposal [$10,000 ($30,000 $16,000)]
Accumulated Depreciation—Truck
Truck
(To record sale of truck at a loss)
10,000
4,000
16,000
30,000
Related exercise material: BE9-9, BE9-10, E9-9, E9-10, and Do it! 9-3.
SECTION 2
413
✓
Natural ResourcesH E L P F U L
The Navigator
HINT
Natural resources consist of standing timber and underground deposits of oil, gas,
and minerals.These long-lived productive assets have two distinguishing characteristics: (1) They are physically extracted in operations (such as mining, cutting, or
pumping). (2) They are replaceable only by an act of nature.
HELPFUL HINT
On a balance sheet,
natural resources may
be described more
specifically as timberlands,
mineral deposits, oil
reserves, and so on.
ACCOUNTING FOR NATURAL RESOURCES
The acquisition cost of a natural resource is the price needed to acquire
STUDY OBJECTIVE 7
the resource and prepare it for its intended use. For an already-discovered Compute periodic depletion of
resource, such as an existing coal mine, cost is the price paid for the property. natural resources.
The allocation of the cost of natural resources to expense in a rational
and systematic manner over the resource’s useful life is called depletion. (That is,
depletion is to natural resources as depreciation is to plant assets.) Companies
generally use the units-of-activity method (learned earlier in the chapter) to compute depletion. The reason is that depletion generally is a function of the units extracted during the year.
Under the units-of-activity method, companies divide the total cost of the natural
resource minus salvage value by the number of units estimated to be in the resource.
The result is a depletion cost per unit of product.They then multiply the depletion cost
per unit by the number of units extracted and sold.The result is the annual depletion
expense. Illustration 9-21 shows the formula to compute depletion expense.
Total Cost
minus Salvage ⴜ
Value
Depletion
Cost per
Unit
Total
Estimated
Units
Depletion
ⴝ Cost per
Unit
Illustration 9-21
Formula to compute
depletion expense
Number of
Annual
ⴛ Units Extracted ⴝ Depletion
and Sold
Expense
To illustrate, assume that Lane Coal Company invests $5 million in a
mine estimated to have 10 million tons of coal and no salvage value. In the
first year, Lane extracts and sells 800,000 tons of coal. Using the formulas
above, Lane computes the depletion expense as follows:
$5,000,000 10,000,000 $0.50 depletion cost per ton
$0.50 800,000 $400,000 annual depletion expense
ETHICS NOTE
Investors were stunned at
news that Royal Dutch/Shell
Group had significantly overstated
its reported oil reserves—and
perhaps had done so intentionally.
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
L
SE
400,000 Exp
Lane records depletion expense for the first year of operation as follows.
Dec. 31
400,000
Cash Flows
no effect
Depletion Expense
Accumulated Depletion
(To record depletion expense on coal
deposits)
400,000
400,000
FINANCIAL STATEMENT PRESENTATION
The company reports the account Depletion Expense as a part of the cost of producing the product. Accumulated Depletion is a contra-asset account, similar to accumulated depreciation. It is deducted from the cost of the natural resource in the
balance sheet, as Illustration 9-22 shows.
Illustration 9-22
Statement presentation of
accumulated depletion
LANE COAL COMPANY
Balance Sheet (partial)
Coal mine
Less: Accumulated depletion
$5,000,000
400,000
$4,600,000
Many companies do not use an Accumulated Depletion account. In such cases, the
company credits the amount of depletion directly to the natural resources account.
Sometimes, a company will extract natural resources in one accounting period
but not sell them until a later period. In this case, the company does not expense
the depletion until it sells the resource. It reports the amount not sold as inventory
in the current assets section.
SECTION 3
Intangible Assets
Intangible assets are rights, privileges, and competitive advantages that result from
the ownership of long-lived assets that do not possess physical substance. Evidence
of intangibles may exist in the form of contracts or licenses. Intangibles may arise
from the following sources:
1. Government grants, such as patents, copyrights, and trademarks.
2. Acquisition of another business, in which the purchase price includes a payment for the company’s favorable attributes (called goodwill).
3. Private monopolistic arrangements arising from contractual agreements, such
as franchises and leases.
Some widely known intangibles are Microsoft’s patents, McDonald’s franchises,
Apple’s trade name iPod, J.K. Rowlings’ copyrights on the Harry Potter books, and
the trademark Rent-A-Wreck in the Feature Story.
ACCOUNTING FOR INTANGIBLE ASSETS
Companies record intangible assets at cost. Intangibles are categorized
as having either a limited life or an indefinite life. If an intangible has a
Explain the basic issues related to
limited life, the company allocates its cost over the asset’s useful life using
accounting for intangible assets.
a process similar to depreciation. The process of allocating the cost of intangibles is referred to as amortization. The cost of intangible assets with indefinite
lives should not be amortized.
STUDY OBJECTIVE 8
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Types of Intangible Assets
To record amortization of an intangible asset, a company increases (debits)
Amortization Expense, and decreases (credits) the specific intangible asset. (Unlike
depreciation, no contra account, such as Accumulated Amortization, is usually used.)
Intangible assets are typically amortized on a straight-line basis. For example,
the legal life of a patent is 20 years. Companies amortize the cost of a patent over
its 20-year life or its useful life, whichever is shorter. To illustrate the computation
of patent amortization, assume that National Labs purchases a patent at a cost
of $60,000. If National estimates the useful life of the patent to be eight years, the
annual amortization expense is $7,500 ($60,000 8). National records the annual
amortization as follows.
HELPFUL HINT
Amortization is to
intangibles what
depreciation is to plant
assets and depletion is
to natural resources.
A
Dec. 31
Amortization Expense—Patent
Patent
(To record patent amortization)
415
L
SE
7,500 Exp
7,500
7,500
Companies classify Amortization Expense—Patents as an operating expense in the
income statement.
There is a difference between intangible assets and plant assets in determining
cost. For plant assets, cost includes both the purchase price of the asset and the
costs incurred in designing and constructing the asset. In contrast, cost for an intangible asset includes only the purchase price. Companies expense any costs incurred
in developing an intangible asset.
TYPES OF INTANGIBLE ASSETS
Patents
A patent is an exclusive right issued by the U.S. Patent Office that enables the
recipient to manufacture, sell, or otherwise control an invention for a period of
20 years from the date of the grant. A patent is nonrenewable. But companies can
extend the legal life of a patent by obtaining new patents for improvements or
other changes in the basic design. The initial cost of a patent is the cash or cash
equivalent price paid to acquire the patent.
The saying, “A patent is only as good as the money you’re prepared to spend
defending it” is very true. Many patents are subject to litigation. Any legal costs an
owner incurs in successfully defending a patent in an infringement suit are considered necessary to establish the patent’s validity. The owner adds those costs to the
Patent account and amortizes them over the remaining life of the patent.
The patent holder amortizes the cost of a patent over its 20-year legal life or its
useful life, whichever is shorter. Companies consider obsolescence and inadequacy
in determining useful life. These factors may cause a patent to become economically ineffective before the end of its legal life.
Copyrights
The federal government grants copyrights which give the owner the exclusive right
to reproduce and sell an artistic or published work. Copyrights extend for the life
of the creator plus 70 years. The cost of a copyright is the cost of acquiring and
defending it. The cost may be only the $10 fee paid to the U.S. Copyright Office. Or
it may amount to much more if an infringement suit is involved.
The useful life of a copyright generally is significantly shorter than its legal life.
Therefore, copyrights usually are amortized over a relatively short period of time.
7,500
Cash Flows
no effect
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Trademarks and Trade Names
A trademark or trade name is a word, phrase, jingle, or symbol that identifies a particular enterprise or product. Trade names like Wheaties, Game Boy, Frappuccino,
Kleenex, Windows, Coca-Cola, and Jeep create immediate product identification.
They also generally enhance the sale of the product.The creator or original user may
obtain exclusive legal right to the trademark or trade name by registering it with the
U.S. Patent Office. Such registration provides 20 years of protection. The registration
may be renewed indefinitely as long as the trademark or trade name is in use.
If a company purchases the trademark or trade name, its cost is the purchase
price. If a company develops and maintains the trademark or trade name, any costs
related to these activities are expensed as incurred. Because trademarks and trade
names have indefinite lives, they are not amortized.
Franchises and Licenses
When you fill up your tank at the corner Shell station, eat lunch at Taco Bell, or rent
a car from Rent-A-Wreck, you are dealing with franchises. A franchise is a contractual arrangement between a franchisor and a franchisee. The franchisor grants the
franchisee the right to sell certain products, provide specific services, or use certain
trademarks or trade names, usually within a designated geographical area.
Another type of franchise is that entered into between a governmental body
(commonly municipalities) and a company.This franchise permits the company to use
public property in performing its services. Examples are the use of city streets for a bus
line or taxi service, use of public land for telephone and electric lines, and the use of airwaves for radio or TV broadcasting. Such operating rights are referred to as licenses.
When a company can identify costs with the purchase of a franchise or license,
it should recognize an intangible asset. Companies should amortize the cost of a
limited-life franchise (or license) over its useful life. If the life is indefinite, the cost
is not amortized. Annual payments made under a franchise agreement are
recorded as operating expenses in the period in which they are incurred.
ACCOUNTING ACROSS THE ORGANIZATION
ESPN Wins Monday Night Football Franchise
What is a well-known franchise worth? Recently ESPN outbid its rivals for the
right to broadcast Monday Night Football. At a price of $1.1 billion per year—
nearly twice what rival ABC paid in previous years—it isn’t clear who won and who lost.
When bidding for a unique franchise like Monday Night Football, management must consider many factors to determine a price. As part of the deal, ESPN also got wireless rights and
Spanish-language telecasts. By its estimation, ESPN will generate a profit of $200 million per
year from Monday Night Football. ABC was losing $150 million per year.
Another factor in the decision was ESPN management’s concern that if ESPN didn’t win
the bid, a buyer would emerge that would use Monday Night Football as a launching pad for
a new sports network. ESPN doesn’t want any more competitors than it already has. It is hard
to put a price tag on the value of keeping the competition to a minimum.
Source: Ronald Grover and Tom Lowry, “A Ball ESPN Couldn’t Afford to Drop,” BusinessWeek, May 2, 2005, p. 42.
How should ESPN account for the $1.1 billion per year franchise fee?
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Research and Development Costs
417
Goodwill
Usually, the largest intangible asset that appears on a company’s balance sheet is
goodwill. Goodwill represents the value of all favorable attributes that relate to a
company. These include exceptional management, desirable location, good customer relations, skilled employees, high-quality products, and harmonious relations
with labor unions. Goodwill is unique: Unlike assets such as investments and plant
assets, which can be sold individually in the marketplace, goodwill can be identified
only with the business as a whole.
If goodwill can be identified only with the business as a whole, how can its
amount be determined? One could try to put a dollar value on the factors listed
above (exceptional management, desirable location, and so on). But the results
would be very subjective, and such subjective valuations would not contribute to
the reliability of financial statements. Therefore, companies record goodwill only
when an entire business is purchased. In that case, goodwill is the excess of cost
over the fair market value of the net assets (assets less liabilities) acquired.
In recording the purchase of a business, the company debits (increases) the net
assets at their fair market values, credits (decreases) cash for the purchase price,
and debits goodwill for the difference. Goodwill is not amortized (because it is considered to have an indefinite life). Companies report goodwill in the balance sheet
under intangible assets.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expenditures that may lead to patents, copyrights, new processes, and new products. Many companies spend considerable sums
of money on research and development (R&D). For example, in a recent year IBM
spent over $6.15 billion on R&D.
Research and development costs present accounting problems. For one thing,
it is sometimes difficult to assign the costs to specific projects. Also, there are
uncertainties in identifying the extent and timing of future benefits. As a result,
companies usually record R&D costs as an expense when incurred, whether the
research and development is successful or not.
To illustrate, assume that Laser Scanner Company spent $3 million on R&D.
This expenditure resulted in two highly successful patents, obtained with $20,000 in
lawyers’ fees. The company would add the lawyers’ fees to the patent account. The
R&D costs, however, cannot be included in the cost of the patent. Instead, the company would record the R&D costs as an expense when incurred.
Many disagree with this accounting approach. They argue that expensing R&D
costs leads to understated assets and net income. Others, however, argue that capitalizing these costs will lead to highly speculative assets on the balance sheet. It is
difficult to determine who is right.The controversy illustrates how difficult it can be
to establish proper guidelines for financial reporting.
HELPFUL HINT
Research and development (R&D) costs are
not intangible assets.
But because they may
lead to patents and
copyrights, we discuss
them in this section.
before you go on...
Do it!
Match the statement with the term most directly associated with it.
Copyright
Intangible assets
Research and development costs
Depletion
Franchise
1.
_______ The allocation of the cost of a natural resource to expense in a rational and systematic manner.
2.
_______ Rights, privileges, and competitive advantages that result from the ownership of
long-lived assets that do not possess physical substance.
Classification Concepts
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Action Plan
• Know that the accounting for
intangibles often depends on
whether the item has a finite or
indefinite life.
• Recognize the many similarities
and differences between the
accounting for natural
resources, plant assets, and
intangible assets.
3.
_______ An exclusive right granted by the federal government to reproduce and sell an
artistic or published work.
4.
________ A right to sell certain products or services or to use certain trademarks or trade
names within a designated geographic area.
5.
________ Costs incurred by a company that often lead to patents or new products. These
costs must be expensed as incurred.
Solution
1.
Depletion
2.
Intangible assets
3.
Copyright
4.
Franchise
5.
Research and development costs
Related exercise material: BE9-11, BE9-12, E9-11, E9-12, E9-13, and Do it! 9-4.
✓
The Navigator
STATEMENT PRESENTATION AND ANALYSIS
Presentation
Usually companies combine plant assets and natural resources under
“Property, plant, and equipment” in the balance sheet. They show intangiIndicate how plant assets, natural
bles separately. Companies disclose either in the balance sheet or the
resources, and intangible assets
notes the balances of the major classes of assets, such as land, buildings,
are reported.
and equipment, and accumulated depreciation by major classes or in total.
In addition, they should describe the depreciation and amortization methods that
were used, as well as disclose the amount of depreciation and amortization expense
for the period.
Illustration 9-23 shows the financial statement presentation of property, plant,
and equipment and intangibles by The Procter & Gamble Company (P&G) in its
2008 balance sheet.The notes to P&G’s financial statements present greater details
about the accounting for its long-term tangible and intangible assets.
STUDY OBJECTIVE 9
Illustration 9-23
P&G’s presentation of property, plant, and equipment,
and intangible assets
THE PROCTER & GAMBLE COMPANY
Balance Sheet (partial)
(in millions)
June 30
2008
2007
Property, plant, and equipment
Buildings
Machinery and equipment
Land
$ 7,052
30,145
889
$ 6,380
27,492
849
Accumulated depreciation
38,086
(17,446)
34,721
(15,181)
20,640
19,540
59,767
34,233
56,552
33,626
$94,000
$90,178
Net property, plant, and equipment
Goodwill and other intangible assets
Goodwill
Trademarks and other intangible assets, net
Net goodwill and other intangible assets
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Statement Presentation and Analysis
419
Illustration 9-24 shows another comprehensive presentation of property, plant,
and equipment, from the balance sheet of Owens-Illinois. The notes to the financial
statements of Owens-Illinois identify the major classes of property, plant, and
equipment. They also indicate that depreciation and amortization are by the
straight-line method, and depletion is by the units-of-activity method.
Illustration 9-24
Owens-Illinois’ presentation
of property, plant, and
equipment, and intangible
assets
OWENS-ILLINOIS, INC.
Balance Sheet (partial)
(in millions)
Property, plant, and equipment
Timberlands, at cost, less accumulated depletion
Buildings and equipment, at cost
Less: Accumulated depreciation
$ 95.4
$2,207.1
1,229.0
978.1
Total property, plant, and equipment
Intangibles
Patents
$1,073.5
410.0
Total
$1,483.5
Analysis
Using ratios, we can analyze how efficiently a company uses its assets to generate
sales. The asset turnover ratio analyzes the productivity of a company’s assets. It
tells us how many dollars of sales a company generates for each dollar invested in
assets. This ratio is computed by dividing net sales by average total assets for the
period. The formula in Illustration 9-25 shows the computation of the asset
turnover ratio for The Procter & Gamble Company. P&G’s net sales for 2008 were
$83,503 million. Its total ending assets were $143,992 million, and beginning assets
were $138,014 million.
Net Sales ⴜ
$83,503
Average Total
Assets
Asset Turnover
ⴝ
Ratio
$143,992 $138,014
2
.59 times
Thus, each dollar invested in assets produced $0.59 in sales for P&G. If a company is using its assets efficiently, each dollar of assets will create a high amount of
sales. This ratio varies greatly among different industries—from those that are asset intensive (utilities) to those that are not (services).
Be sure to read
all about Y
*U
Buying a Wreck
of Your Own
on page 420 for
information on how topics
in this chapter apply to
your personal life.
Illustration 9-25
Asset turnover formula
and computation
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all about Y
Page 420
*U
Buying a Wreck of Your Own
T
The opening story to this chapter discusses car rental
company Rent-A-Wreck. Recall that Rent-A-Wreck
determined it can maximize its profitability by
buying and renting used, rather than new, cars. What
about you? Could you maximize your economic wellbeing by buying a used car rather than a new one?
*
*About the Numbers
There are many costs to consider in deciding whether to buy a new or used car.
These costs include the down payment, monthly loan payments, insurance, maintenance and repair costs, and state (department of motor vehicle) fees. The graph
below compares the total costs over five years for the typical new versus used car.
Cost of Car Ownership
Some Facts
* There are approximately 250 million vehicles in
operation in the U.S. Around the world, there were
806 million cars and light trucks on the road in
2007. Currently, these vehicles burn over 260 billion
gallons of fuel yearly.
* In the U.S., the 2008 car and light-truck market
dropped diamatically, to approximately 13.2 million
units, down by about 2.9 million from 2007.
First-Year Expenses
$30k
Total Five-Year Expenses
Adjusted Five-Year Expenses
(Allowing for equity in owned
vehicle)
$25k
$20k
$15k
* The cost of an average new car is about $22,000.
The price of the average used car is now about
$13,900.
* Financial institutions typically require a down
payment of at least 10% of the value of a vehicle
on a vehicle loan. Thus, the average new car will
require a much higher down payment. However,
interest rates on used-car loans are higher than on
new-car loans.
* To stimulate car sales, individuals can generally
deduct fees and taxes on the purchase price of a
qualified new car, light truck, motor home, or
motorcycle.
* A new car typically loses at least 30% of its value
during the first two years, and about 40 to 50%
after three years. Some brands maintain their value
better than others.
* To keep monthly car payments down, car companies
will now provide financing for up to six years. (It
used to be two or three years.) With such a long
loan, you might end up “upside down on the
loan”—that is, you might actually owe more money
than the car is worth if you decide to sell the car
before the end of the loan.
$10k
$5k
New
Used
Source for graph: Phillip Reed, “Compare the Costs: Buying vs. Leasing vs. Buying a Used Car,”
www.edmunds.com/advice/buying/articles/47079/article.html (accessed May 2006).
*What Do You Think?
Should you buy a new car?
YES: I have enough stress in my life. I don’t want to worry about my car
breaking down—and if it does break down, I want it to be covered by a warranty. Besides, I have an image to maintain—I don’t want to be seen in
anything less than the latest styling and the latest technology.
NO: I’m a college student, and I need to keep my costs down. Also, used
cars are a lot more dependable than they used to be. In addition, my selfimage is strong enough that I don’t need a fancy new car to feel good about
myself (despite what the car advertisements say).
Source: Michelle Krebs, “Should You Buy New or Used?” www.cars.com/go/advice, May 3, 2005.
420
*
The authors’ comments on this situation appear on page 443.
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Comprehensive Do it!
Comprehensive Do it!
421
1
DuPage Company purchases a factory machine at a cost of $18,000 on January 1, 2011. DuPage
expects the machine to have a salvage value of $2,000 at the end of its 4-year useful life.
During its useful life, the machine is expected to be used 160,000 hours.Actual annual hourly
use was: 2011, 40,000; 2012, 60,000; 2013, 35,000; and 2014, 25,000.
Instructions
Prepare depreciation schedules for the following methods: (a) straight-line, (b) units-of-activity,
and (c) declining-balance using double the straight-line rate.
Solution to Comprehensive
Do it!
1
(a)
Straight-Line Method
Computation
Year
Depreciable
Cost*
2011
2012
2013
2014
$16,000
16,000
16,000
16,000
Depreciation
Rate
ⴛ
ⴝ
25%
25%
25%
25%
End of Year
Annual
Depreciation
Expense
Accumulated
Depreciation
$4,000
4,000
4,000
4,000
$ 4,000
8,000
12,000
16,000
Book
Value
$14,000**
10,000
6,000
2,000
*$18,000 $2,000.
**$18,000 $4,000.
(b)
Units-of-Activity Method
Computation
Year
Units of
Activity
2011
2012
2013
2014
40,000
60,000
35,000
25,000
Depreciation
Cost/Unit
ⴛ
ⴝ
$0.10*
0.10
0.10
0.10
End of Year
Annual
Depreciation
Expense
Accumulated
Depreciation
Book
Value
$4,000
6,000
3,500
2,500
$ 4,000
10,000
13,500
16,000
$14,000
8,000
4,500
2,000
*($18,000 $2,000) 160,000.
(c)
Declining-Balance Method
Computation
Year
Book Value
Beginning of
Year
2011
2012
2013
2014
$18,000
9,000
4,500
2,250
ⴛ
Depreciation
Rate*
50%
50%
50%
50%
ⴝ
Annual
Depreciation
Expense
$9,000
4,500
2,250
250**
End of Year
Accumulated
Depreciation
Book
Value
$ 9,000
13,500
15,750
16,000
$9,000
4,500
2,250
2,000
*1⁄4 2.
**Adjusted to $250 because ending book value should not be less than expected salvage value.
✓
The Navigator
Action Plan
• Under the straight-line method,
apply the depreciation rate to
depreciable cost.
• Under the units-of-activity
method, compute the depreciation cost per unit by dividing
depreciable cost by total units
of activity.
• Under the declining-balance
method, apply the depreciation
rate to the book value at the
beginning of the year.
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Comprehensive Do it!
2
On January 1, 2011, Skyline Limousine Co. purchased a limo at an acquisition cost of $28,000.
The vehicle has been depreciated by the straight-line method using a 4-year service life and a
$4,000 salvage value. The company’s fiscal year ends on December 31.
Instructions
Action Plan
• At the time of disposal, determine the book value of the
asset.
• Recognize any gain or loss from
disposal of the asset.
• Remove the book value of the
asset from the records by debiting Accumulated Depreciation
for the total depreciation to
date of disposal and crediting
the asset account for the cost
of the asset.
Prepare the journal entry or entries to record the disposal of the limousine assuming that
it was:
(a) Retired and scrapped with no salvage value on January 1, 2015.
(b) Sold for $5,000 on July 1, 2014.
Solution to Comprehensive
(a)
(b)
1/1/15
7/1/14
Do it!
2
Accumulated Depreciation—Limousine
Loss on Disposal
Limousine
(To record retirement of limousine)
Depreciation Expense
Accumulated Depreciation—Limousine
(To record depreciation to date of disposal)
Cash
Accumulated Depreciation—Limousine
Loss on Disposal
Limousine
(To record sale of limousine)
24,000
4,000
28,000
3,000
3,000
5,000
21,000
2,000
28,000
✓
The Navigator
SUMMARY OF STUDY OBJECTIVES
1 Describe how the cost principle applies to plant
assets. The cost of plant assets includes all expenditures
necessary to acquire the asset and make it ready for its intended use. Cost is measured by the cash or cash equivalent
price paid.
2 Explain the concept of depreciation. Depreciation is
the allocation of the cost of a plant asset to expense over its
useful (service) life in a rational and systematic manner.
Depreciation is not a process of valuation, nor is it a
process that results in an accumulation of cash.
3 Compute periodic depreciation using different methods.
Three depreciation methods are:
Method
Straight-line
Effect on
Annual
Depreciation
Units-ofactivity
Constant
amount
Varying
amount
Decliningbalance
Decreasing
amount
Formula
Depreciable cost
Useful life (in years)
Depreciation cost per
unit Units of activity
during the year
Book value at beginning
of year Decliningbalance rate
4 Describe the procedure for revising periodic depreciation. Companies make revisions of periodic depreciation in present and future periods, not retroactively. They
determine the new annual depreciation by dividing the
depreciable cost at the time of the revision by the remaining useful life.
5 Distinguish between revenue and capital expenditures, and explain the entries for each. Companies incur
revenue expenditures to maintain the operating efficiency
and productive life of an asset. They debit these expenditures to Repair Expense as incurred. Capital expenditures
increase the operating efficiency, productive capacity, or
expected useful life of the asset. Companies generally debit
these expenditures to the plant asset affected.
6 Explain how to account for the disposal of a plant
asset. The accounting for disposal of a plant asset through
retirement or sale is as follows:
(a) Eliminate the book value of the plant asset at the date
of disposal.
(b) Record cash proceeds, if any.
(c) Account for the difference between the book value and
the cash proceeds as a gain or loss on disposal.
7 Compute periodic depletion of natural resources.
Companies compute depletion cost per unit by dividing the
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Glossary
total cost of the natural resource minus salvage value by
the number of units estimated to be in the resource. They
then multiply the depletion cost per unit by the number of
units extracted and sold.
8 Explain the basic issues related to accounting for
intangible assets. The process of allocating the cost of an
intangible asset is referred to as amortization. The cost of
intangible assets with indefinite lives are not amortized.
Companies normally use the straight-line method for
amortizing intangible assets.
9 Indicate how plant assets, natural resources, and
intangible assets are reported. Companies usually
423
combine plant assets and natural resources under property,
plant, and equipment; they show intangibles separately
under intangible assets. Either within the balance sheet or
in the notes, companies should disclose the balances of the
major classes of assets, such as land, buildings, and equipment, and accumulated depreciation by major classes or in
total. They also should describe the depreciation and amortization methods used, and should disclose the amount of
depreciation and amortization expense for the period. The
asset turnover ratio measures the productivity of a company’s assets in generating sales.
✓
The Navigator
GLOSSARY
Accelerated-depreciation method Depreciation method
that produces higher depreciation expense in the early
years than in the later years. (p. 407).
Additions and improvements Costs incurred to increase
the operating efficiency, productive capacity, or useful life
of a plant asset. (p. 409).
Amortization The allocation of the cost of an intangible
asset to expense over its useful life in a systematic and
rational manner. (p. 414).
Asset turnover ratio A measure of how efficiently a company uses its assets to generate sales; calculated as net sales
divided by average total assets. (p. 419).
Capital expenditures Expenditures that increase the company’s investment in productive facilities. (p. 409).
Copyright Exclusive grant from the federal government
that allows the owner to reproduce and sell an artistic or
published work. (p. 415).
Declining-balance method Depreciation method that
applies a constant rate to the declining book value of the
asset and produces a decreasing annual depreciation expense over the useful life of the asset. (p. 406).
Depletion The allocation of the cost of a natural resource to
expense in a rational and systematic manner over the
resource’s useful life. (p. 413).
Depreciation The process of allocating to expense the cost
of a plant asset over its useful (service) life in a rational and
systematic manner. (p. 402).
Depreciable cost The cost of a plant asset less its salvage
value. (p. 404).
Franchise (license) A contractual arrangement under
which the franchisor grants the franchisee the right to sell
certain products, provide specific services, or use certain
trademarks or trade names, usually within a designated
geographical area. (p. 416).
Going-concern assumption States that the company will
continue in operation for the foreseeable future. (p. 403).
Goodwill The value of all favorable attributes that relate to
a business enterprise. (p. 417).
Intangible assets Rights, privileges, and competitive advantages that result from the ownership of long-lived assets
that do not possess physical substance. (p. 414).
Licenses Operating rights to use public property, granted to
a business enterprise by a governmental agency. (p. 416).
Materiality principle If an item would not make a difference in decision making, a company does not have to follow GAAP in reporting it. (p. 410).
Natural resources Assets that consist of standing timber
and underground deposits of oil, gas, or minerals. (p. 413).
Ordinary repairs Expenditures to maintain the operating
efficiency and productive life of the unit. (p. 409).
Patent An exclusive right issued by the U.S. Patent Office
that enables the recipient to manufacture, sell, or otherwise
control an invention for a period of 20 years from the date
of the grant. (p. 415).
Plant assets Tangible resources that are used in the operations of the business and are not intended for sale to customers. (p. 398).
Research and development (R&D) costs Expenditures
that may lead to patents, copyrights, new processes, or new
products. (p. 417).
Revenue expenditures Expenditures that are immediately
charged against revenues as an expense. (p. 409).
Salvage value An estimate of an asset’s value at the end of
its useful life. (p. 403).
Straight-line method Depreciation method in which periodic depreciation is the same for each year of the asset’s
useful life. (p. 404).
Trademark (trade name) A word, phrase, jingle, or
symbol that identifies a particular enterprise or product.
(p. 416).
Units-of-activity method Depreciation method in which
useful life is expressed in terms of the total units of production or use expected from an asset. (p. 405).
Useful life An estimate of the expected productive life, also
called service life, of an asset. (p. 403).
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
Exchange of Plant Assets
APPENDIX
Ordinarily, companies record a gain or loss on the exchange of plant assets. The rationale for recognizing a gain or loss is that most exchanges
Explain how to account for the
have commercial substance. An exchange has commercial substance if the
exchange of plant assets.
future cash flows change as a result of the exchange.
To illustrate, Ramos Co. exchanges some of its equipment for land held by
Brodhead Inc. It is likely that the timing and amount of the cash flows arising from
the land will differ significantly from the cash flows arising from the equipment. As
a result, both Ramos and Brodhead are in different economic positions.
Therefore the exchange has commercial substance, and the companies recognize a
gain or loss in the exchange. Because most exchanges have commercial substance
(even when similar assets are exchanged), we illustrate only this type of situation,
for both a loss and a gain.
STUDY OBJECTIVE 10
Loss Treatment
To illustrate an exchange that results in a loss, assume that Roland Company
exchanged a set of used trucks plus cash for a new semi-truck.The used trucks have
a combined book value of $42,000 (cost $64,000 less $22,000 accumulated depreciation). Roland’s purchasing agent, experienced in the second-hand market, indicates that the used trucks have a fair market value of $26,000. In addition to the
trucks, Roland must pay $17,000 for the semi-truck. Roland computes the cost of
the semi-truck as follows.
Illustration 9A-1
Cost of semi-truck
Fair value of used trucks
Cash paid
Cost of semi-truck
$26,000
17,000
$43,000
Roland incurs a loss on disposal of $16,000 on this exchange. The reason is that
the book value of the used trucks is greater than the fair market value of these
trucks. The computation is as follows.
Illustration 9A-2
Computation of loss on
disposal
A
L
SE
43,000
22,000
16,000 Exp
64,000
17,000
Cash Flows
17,000
Book value of used trucks ($64,000 $22,000)
Fair market value of used trucks
Loss on disposal
$42,000
26,000
$16,000
In recording an exchange at a loss, three steps are required: (1) Eliminate
the book value of the asset given up, (2) record the cost of the asset acquired, and
(3) recognize the loss on disposal. Roland Company thus records the exchange on
the loss as follows.
Semi-truck
Accumulated Depreciation—Used Trucks
Loss on Disposal
Used Trucks
Cash
(To record exchange of used trucks for semi-truck)
43,000
22,000
16,000
64,000
17,000
Gain Treatment
To illustrate a gain situation, assume that Mark Express Delivery decides to exchange
its old delivery equipment plus cash of $3,000 for new delivery equipment. The book
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Self-Study Questions
425
value of the old delivery equipment is $12,000 (cost $40,000 less accumulated depreciation $28,000). The fair market value of the old delivery equipment is $19,000.
The cost of the new asset is the fair market value of the old asset exchanged
plus any cash paid (or other consideration given up). The cost of the new delivery
equipment is $22,000 computed as follows.
Fair market value of old delivery equipment
Cash paid
Cost of new delivery equipment
Illustration 9A-3
Cost of new delivery
equipment
$19,000
3,000
$22,000
A gain results when the fair market value of the old delivery equipment is
greater than its book value. For Mark Express there is a gain of $7,000 on disposal,
computed as follows.
Fair market value of old delivery equipment
Book value of old delivery equipment ($40,000 $28,000)
Gain on disposal
Illustration 9A-4
Computation of gain on
disposal
$19,000
12,000
$ 7,000
Mark Express Delivery records the exchange as follows.
Delivery Equipment (new)
Accumulated Depreciation—Delivery Equipment (old)
Delivery Equipment (old)
Gain on Disposal
Cash
(To record exchange of old delivery equipment
for new delivery equipment)
22,000
28,000
A
40,000
7,000
3,000
L
SE
22,000
28,000
40,000
7,000 Rev
3,000
Cash Flows
In recording an exchange at a gain, the following three steps are involved: (1) Eliminate the book value of the asset given up, (2) record the cost of the asset acquired,
and (3) recognize the gain on disposal. Accounting for exchanges of plant assets
becomes more complex if the transaction does not have commercial substance.
This issue is discussed in more advanced accounting classes.
3,000
SUMMARY OF STUDY OBJECTIVE FOR APPENDIX
10 Explain how to account for the exchange of plant
assets. Ordinarily companies record a gain or loss on the
exchange of plant assets. The rationale for recognizing a
gain or loss is that most exchanges have commercial substance. An exchange has commercial substance if the future cash flows change as a result of the exchange.
*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.
SELF-STUDY QUESTIONS
(SO 1)
Answers are at the end of the chapter.
1. Erin Danielle Company purchased equipment and incurred the following costs.
Cash price
$24,000
Sales taxes
1,200
Insurance during transit
200
Installation and testing
400
Total costs
$25,800
What amount should be recorded as the cost of the
equipment?
a. $24,000.
c. $25,400.
b. $25,200.
d. $25,800.
2. Depreciation is a process of:
(SO 2)
a. valuation.
b. cost allocation.
c. cash accumulation.
d. appraisal.
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(SO 3)
(SO 3)
(SO 3)
(SO 4)
(SO 4)
(SO 5)
(SO 6)
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Chapter 9 Plant Assets, Natural Resources, and Intangible Assets
3. Micah Bartlett Company purchased equipment on
January 1, 2010, at a total invoice cost of $400,000. The
equipment has an estimated salvage value of $10,000 and
an estimated useful life of 5 years. The amount of accumulated depreciation at December 31, 2011, if the straightline method of depreciation is used, is:
a. $80,000.
b. $160,000.
c. $78,000.
d. $156,000.
4. Ann Torbert purchased a truck for $11,000 on January 1,
2010. The truck will have an estimated salvage value of
$1,000 at the end of 5 years. Using the units-of-activity
method, the balance in accumulated depreciation at
December 31, 2011, can be computed by the following
formula:
a. ($11,000 Total estimated activity) Units of activity
for 2011.
b. ($10,000 Total estimated activity) Units of activity
for 2011.
c. ($11,000 Total estimated activity) Units of activity
for 2010 and 2011.
d. ($10,000 Total estimated activity) Units of activity
for 2010 and 2011.
5. Jefferson Company purchased a piece of equipment on
January 1, 2011. The equipment cost $60,000 and had an
estimated life of 8 years and a salvage value of $8,000.
What was the depreciation expense for the asset for 2012
under the double-declining-balance method?
a. $6,500.
b. $11,250.
c. $15,000.
d. $6,562.
6. When there is a change in estimated depreciation:
a. previous depreciation should be corrected.
b. current and future years’ depreciation should be revised.
c. only future years’ depreciation should be revised.
d. None of the above.
7. Able Towing Company purchased a tow truck for $60,000
on January 1, 2011. It was originally depreciated on a
straight-line basis over 10 years with an assumed salvage
value of $12,000. On December 31, 2013, before adjusting
entries had been made, the company decided to change
the remaining estimated life to 4 years (including 2013)
and the salvage value to $2,000. What was the depreciation expense for 2013?
a. $6,000.
b. $4,800.
c. $15,000.
d. $12,100.
8. Additions to plant assets are:
a. revenue expenditures.
b. debited to a Repair Expense account.
c. debited to a Purchases account.
d. capital expenditures.
9. Bennie Razor Company has decided to sell one of its old
manufacturing machines on June 30, 2011. The machine
was purchased for $80,000 on January 1, 2007, and was de-
preciated on a straight-line basis for 10 years assuming no
salvage value. If the machine was sold for $26,000, what
was the amount of the gain or loss recorded at the time of
the sale?
a. $18,000.
b. $54,000.
c. $22,000.
d. $46,000.
10. Maggie Sharrer Company expects to extract 20 million (SO 7)
tons of coal from a mine that cost $12 million. If no
salvage value is expected, and 2 million tons are mined
and sold in the first year, the entry to record depletion
will include a:
a. debit to Accumulated Depletion of $2,000,000.
b. credit to Depletion Expense of $1,200,000.
c. debit to Depletion Expense of $1,200,000.
d. credit to Accumulated Depletion of $2,000,000.
11. Which of the following statements is false?
(SO 8)
a. If an intangible asset has a finite life, it should be
amortized.
b. The amortization period of an intangible asset can
exceed 20 years.
c. Goodwill is recorded only when a business is purchased.
d. Research and development costs are expensed when
incurred, except when the research and development
expenditures result in a successful patent.
12. Martha Beyerlein Company incurred $150,000 of research (SO 8)
and development costs in its laboratory to develop a
patent granted on January 2, 2011. On July 31, 2011,
Beyerlein paid $35,000 for legal fees in a successful defense of the patent. The total amount debited to Patents
through July 31, 2011, should be:
a. $150,000.
b. $35,000.
c. $185,000.
d. $170,000.
(SO 9)
13. Indicate which of the following statements is true.
a. Since intangible assets lack physical substance, they
need be disclosed only in the notes to the financial
statements.
b. Goodwill should be reported as a contra-account in the
owner’s equity section.
c. Totals of major classes of assets can be shown in the
balance sheet, with asset details disclosed in the notes
to the financial statements.
d. Intangible assets are typically combined with plant assets and natural resources and shown in the property,
plant, and equipment section.
14. Lake Coffee Company reported net sales of $180,000, net (SO 9)
income of $54,000, beginning total assets of $200,000, and
ending total assets of $300,000. What was the company’s
asset turnover ratio?
a. 0.90
b. 0.20
c. 0.72
d. 1.39
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427
(SO 10) *15. Schopenhauer Company exchanged an old machine, with *16. In exchanges of assets in which the exchange has commer- (SO 10)
a book value of $39,000 and a fair market value of $35,000,
and paid $10,000 cash for a similar new machine. The
transaction has commercial substance. At what amount
should the machine acquired in the exchange be recorded
on Schopenhauer’s books?
a. $45,000.
b. $46,000.
c. $49,000.
d. $50,000.
cial substance:
a. neither gains nor losses are recognized immediately.
b. gains, but not losses, are recognized immediately.
c. losses, but not gains, are recognized immediately.
d. both gains and losses are recognized immediately.
Go to the book’s companion website,
www.wiley.com/college/weygandt,
for Additional Self-Study Questions.
✓
The Navigator
QUESTIONS
1. Tim Hoover is uncertain about the applicability of the cost
principle to plant assets. Explain the principle to Tim.
2. What are some examples of land improvements?
3. Dain Company acquires the land and building owned by
Corrs Company. What types of costs may be incurred to
make the asset ready for its intended use if Dain Company
wants to use (a) only the land, and (b) both the land and
the building?
4. In a recent newspaper release, the president of Keene
Company asserted that something has to be done about
depreciation. The president said, “Depreciation does not
come close to accumulating the cash needed to replace the
asset at the end of its useful life.” What is your response to
the president?
5. Robert is studying for the next accounting examination.
He asks your help on two questions: (a) What is salvage
value? (b) Is salvage value used in determining periodic
depreciation under each depreciation method? Answer
Robert’s questions.
6. Contrast the straight-line method and the units-of-activity
method as to (a) useful life, and (b) the pattern of periodic
depreciation over useful life.
7. Contrast the effects of the three depreciation methods on
annual depreciation expense.
8. In the fourth year of an asset’s 5-year useful life, the company decides that the asset will have a 6-year service life.
How should the revision of depreciation be recorded? Why?
9. Distinguish between revenue expenditures and capital expenditures during useful life.
10. How is a gain or loss on the sale of a plant asset computed?
11. Mendez Corporation owns a machine that is fully depreciated but is still being used. How should Mendez account
for this asset and report it in the financial statements?
12. What are natural resources, and what are their distinguishing characteristics?
13. Explain what depletion is and how it is computed.
14. What are the similarities and differences between the
terms depreciation, depletion, and amortization?
15. Pendergrass Company hires an accounting intern who
says that intangible assets should always be amortized
over their legal lives. Is the intern correct? Explain.
16. Goodwill has been defined as the value of all favorable
attributes that relate to a business enterprise. What types
of attributes could result in goodwill?
17. Kenny Sain, a business major, is working on a case problem for one of his classes. In the case problem, the
company needs to raise cash to market a new product it
developed. Joe Morris, an engineering major, takes one
look at the company’s balance sheet and says, “This company has an awful lot of goodwill. Why don’t you recommend that they sell some of it to raise cash?” How should
Kenny respond to Joe?
18. Under what conditions is goodwill recorded?
19. Often research and development costs provide companies
with benefits that last a number of years. (For example,
these costs can lead to the development of a patent that
will increase the company’s income for many years.)
However, generally accepted accounting principles require that such costs be recorded as an expense when incurred. Why?
20. McDonald’s Corporation reports total average assets of
$28.9 billion and net sales of $20.5 billion. What is the
company’s asset turnover ratio?
21. Resco Corporation and Yapan Corporation operate in
the same industry. Resco uses the straight-line method to
account for depreciation; Yapan uses an accelerated
method. Explain what complications might arise in trying
to compare the results of these two companies.
22. Lopez Corporation uses straight-line depreciation for
financial reporting purposes but an accelerated method
for tax purposes. Is it acceptable to use different methods
for the two purposes? What is Lopez’s motivation for doing this?
23. You are comparing two companies in the same industry.
You have determined that May Corp. depreciates its plant
assets over a 40-year life, whereas Won Corp. depreciates
its plant assets over a 20-year life. Discuss the implications
this has for comparing the results of the two companies.
24. Wade Company is doing significant work to revitalize its
warehouses. It is not sure whether it should capitalize
these costs or expense them. What are the implications for
current-year net income and future net income of expensing versus capitalizing these costs?
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25.
What classifications and amounts are shown in *27. Tatum Refrigeration Company trades in an old machine
PepsiCo’s Note 4 to explain its total property, plant, and
on a new model when the fair market value of the old
equipment (net) of $11,663 million?
machine is greater than its book value. The transaction has
commercial substance. Should Tatum recognize a gain on dis*26. When assets are exchanged in a transaction involving
posal? If the fair market value of the old machine is less than
commercial substance, how is the gain or loss on disposal
its book value, should Tatum recognize a loss on disposal?
computed?
BRIEF EXERCISES
Determine the cost of land.
(SO 1)
Determine the cost of a truck.
(SO 1)
Compute straight-line
depreciation.
(SO 3)
Compute depreciation and
evaluate treatment.
(SO 3)
Compute declining-balance
depreciation.
(SO 3)
Compute depreciation using
the units-of-activity method.
(SO 3)
Compute revised depreciation.
(SO 4)
Prepare entries for delivery
truck costs.
(SO 5)
BE9-1 The following expenditures were incurred by Obermeyer Company in purchasing land:
cash price $70,000, accrued taxes $3,000, attorneys’ fees $2,500, real estate broker’s commission
$2,000, and clearing and grading $3,500. What is the cost of the land?
BE9-2 Neeley Company incurs the following expenditures in purchasing a truck: cash price
$30,000, accident insurance $2,000, sales taxes $1,500, motor vehicle license $100, and painting
and lettering $400. What is the cost of the truck?
BE9-3 Conlin Company acquires a delivery truck at a cost of $42,000. The truck is expected to
have a salvage value of $6,000 at the end of its 4-year useful life. Compute annual depreciation
for the first and second years using the straight-line method.
BE9-4 Ecklund Company purchased land and a building on January 1, 2011. Management’s
best estimate of the value of the land was $100,000 and of the building $200,000. But management told the accounting department to record the land at $220,000 and the building at $80,000.
The building is being depreciated on a straight-line basis over 20 years with no salvage value.
Why do you suppose management requested this accounting treatment? Is it ethical?
BE9-5 Depreciation information for Conlin Company is given in BE9-3. Assuming the
declining-balance depreciation rate is double the straight-line rate, compute annual depreciation
for the first and second years under the declining-balance method.
BE9-6 Speedy Taxi Service uses the units-of-activity method in computing depreciation on its
taxicabs. Each cab is expected to be driven 150,000 miles. Taxi no. 10 cost $33,500 and is expected
to have a salvage value of $500. Taxi no. 10 is driven 30,000 miles in year 1 and 20,000 miles in
year 2. Compute the depreciation for each year.
BE9-7 On January 1, 2011, the Ramirez Company ledger shows Equipment $29,000 and
Accumulated Depreciation $9,000. The depreciation resulted from using the straight-line
method with a useful life of 10 years and salvage value of $2,000. On this date, the company concludes that the equipment has a remaining useful life of only 4 years with the same salvage value.
Compute the revised annual depreciation.
BE9-8
Firefly Company had the following two transactions related to its delivery truck.
1. Paid $45 for an oil change.
2. Paid $400 to install special shelving units, which increase the operating efficiency of the truck.
Prepare Firefly’s journal entries to record these two transactions.
Prepare entries for disposal
by retirement.
(SO 6)
Prepare entries for disposal
by sale.
(SO 6)
Prepare depletion expense entry
and balance sheet presentation
for natural resources.
(SO 7)
BE9-9
Prepare journal entries to record the following.
(a) Gomez Company retires its delivery equipment, which cost $41,000. Accumulated depreciation is a...
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