9 PLANT AND INTANGIBLE ASSETS

Chapter Summary
The material on plant assets is organized into sections for tangible assets, intangible assets, and natural resources. For all three categories of plant assets the chapter focuses on three accountable events: (1) acquisition, (2) allocation of the acquisition cost to e pense over the asset!s lifetime, and (") sale or disposal. #n determining the cost of a plant asset, careful attention is paid to distinguishing bet$een capital and revenue e penditures. %pecial considerations surrounding the acquisition of land, e isting structures, and land improvements are briefl& discussed, as is the allocation of lump'sum purchases. ( considerable amount of attention is paid to depreciation. )efore discussing various methods of calculating periodic depreciation, a conceptual introduction e plains that depreciation is simpl& the process of allocating a recorded cost and does not represent an accounting effort to establish the mar*et value of a plant asset. (t this point in the course, the student is alread& a$are of the calculation of straight'line depreciation and the ad+usting entr& to record the e pense. (ccounting for residual values and dealing $ith fractional periods completes the discussion from prior chapters. (ccelerated depreciation is introduced using the declining balance method for illustration. (dditional depreciation methods are discussed in a Supplemental Topic. (ccounting for the disposal of plant assets requires a +ournal entr& to remove both the original recorded cost of the asset and the accumulated depreciation. The chapter deals $ith sales for cash, trade'ins, and scrapping $orthless equipment. The calculation of gain or loss is illustrated onl& for financial statement purposes. Trade'in transactions are treated onl& briefl& at an introductor& level. ( $ide variet& of intangible assets including trademar*s, patents, cop&rights, and franchises is discussed, but onl& good$ill is treated in detail. The difficult& of ob+ectivel& estimating good$ill is e plained as the reason that this asset is onl& recorded $hen purchased. The brief discussion of natural resources parallels that for equipment. ,e emphasize that depletion is first recorded as inventor& and charged to e pense as the material is sold.

Learning Objectives
1. Deter mi n e the cost of plant ass e t s . 2. Distinguish betw e e n ca pi t a l ex p e n d i t u r e s and re v e n u e ex p e n d i t u r e s . 3. Comput e met h o d s . depr e ciation by the st r a i g h t - lin e and d e c li n i n g - bal a n c e

4. Account for dispos al s of plant ass e t s . 5. Explain the nat ur e of intangible ass e t s , including go o d w i l l .

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6. 7.

Account for the d e p l e t i o n of natur al resourc e s . Explain the cash effect s of tran s a c tio n s involving plant ass e t s .

*8. Account for depr e cia tion using met h o d s other tha n straight- line or decliningbalanc e .

Brief topical outline

A (cquisition of plant assets 1 4etermining cost: an e ample 2 %ome special considerations a 5and b 5and improvements c )uildings d 6quipment e (llocation of a lump'sum purchase ' see Your Turn (page 370) 3 1apital e penditures and revenue e penditures B 4epreciation 1 (llocating the cost of plant and equipment over the &ears of use a 4epreciation is not a process of valuation ' see Cash Effects (page 372) b )oo* value b. 1auses of depreciation a 7h&sical deterioration b 8bsolescence ' see Case in Point (page 372) 3 .ethods of computing depreciation a The straight'line method ' see Your Turn (page 375) b 4epreciation for fractional periods c The declining'balance method d 4ouble'declining'balance e 1329'declining'balance 4 Which depr e ci a tio n met h o d s do most busin e s s e s use? a The difference in depreciation methods: are the& :real;< ' see Cash Effects (page 379) and Your Turn (page 379) 5 Financial statement disclosures a 6stimates of useful life and residual value b The principle of consistenc& c =evision of estimated useful lives 6 The impairment of plant assets ' see Case in Point (page 381) C 4isposal of plant and equipment 1 /ains and losses on disposals of plant and equipment ' see Case in Point (page 381) a 4isposal at a price above boo* value b 4isposal at a price belo$ boo* value 2 Trading in used assets for ne$ ones

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D #ntangible assets 1 1haracteristics 2 8perating e penses versus intangible assets 3 (mortization 4 /ood$ill a 6stimating good$ill b =ecording good$ill in the accounts' see Case in Point (page 386) 5 7atents 6 Trademar*s and trade names 7 Franchises > see Your Turn (page 387) 8 1op&rights 9 8ther intangibles and deferred charges > see Mana ement Strate ! (page 388) 10 =esearch and development (= ? 4) costs E Financial anal&sis F @atural resources 1 (ccounting for natural resources a 4epreciation of buildings and equipment closel& related to natural resources 2 4epreciation, amortization, and depletion''a common goal G 7lant transactions and the statement of cash flo$s ' see Cash Effects (page 390) 1 @oncash investing activities H 1oncluding remar*s > see " Secon# $oo% (page 391) Supplemental Topic AI 8ther depreciation methods 1 The units'of'output method 2 .(1=% 3 %um'of'the'&earsB digits 4 4ecelerated depreciation methods 5 4epreciation methods in use: a surve&

Topical coverage and suggested assignment

Homework A !"#me#$ %&o Be Com'(e$ed )r!or $o C(a ) C(a *ee$!#" o# C+a'$er 1 2 " &o'!ca( ,-$(!#e Co.era"e (') 1'4 6 'A# D! c- !o# /-e $!o# C, 3, D, E 1D, 1E, 21, 22 E0erc! e 2, ", C E, F 11, 1", 1C )rob(em 1, 2, " C, 3 G Ca e 1 " I#$er#e$ 1

Comments and observations

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&eac+!#" ob1ec$!.e 2or C+a'$er 9 This chapter covers accounting for plant assets, including acquisition, depreciation, and disposal. (lso included in the chapter are accounting for intangible assets and brief coverage of natural resources. 8ur ob+ectives in presenting this material are to: 1 4escribe plant assets as a Hstream of servicesH to be received b& the business entit&. 2 4istinguish bet$een capital e penditures and revenue e penditures. 3 6 plain and illustrate depreciation as a technique for allocating costs. 4 6 plain and illustrate the mechanics of the depreciation methods discussed in the chapter. 5 6 plain and illustrate accounting for disposals of plant assets, including Hli*e'*indH e changes. 6 6 plain the nature of intangible assets. 7 4iscuss techniques for estimating the value of the good$ill possessed b& a successful business. 8 6 plain and illustrate depletionI relate depreciation, amortization, and depletion to the matching principle. 39 4iscuss the determination of depreciation e pense under the units'of'output and sum' of'the'&earsB digits methods. 4ew 2ea$-re !# C+a'$er 9 #n general terms, our coverage of plant assets is unchanged from the previous edition. The prior coverage of .(1=% has been substantiall& reduced. %everal ne$ Case in Point capsules have been added to illustrate obsolescence, gains and losses on asset dispositions, research and development, and the purchase of good$ill. The assignment material includes ne$ e ercises concerning personal use of accounting information, ethical issues, and recording good$ill.

General comments
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%ome students have difficult& in identif&ing the t&pes of e penditures included in the cost of an asset, and in distinguishing bet$een capital e penditures and revenue e penditures. ,e recommend an in'class revie$ of 4iscussion Juestions 5 and 6 and of 6 ercise 2 to clarif& these points. The most important topic in this chapter is depreciation. 7erhaps the greatest challenge in e plaining depreciation is to dispel the idea that depreciation represents a decline in mar*et value. %tudents are familiar $ith the term depreciation as it relates to the mar*et value of an automobile. 4iscussion Juestion 9 and the diagram on page 371 are both designed to stress the idea that depreciation is a cost allocation process, not a valuation process. ,e recommend discussing in class the e tent to $hich depreciation is based upon +udgments (estimates), and the roles of management and auditors in ma*ing and evaluating these +udgments. 8ur Your Turn case on page 370 can be used to stimulate this discussion. The one form of depreciation calculation that requires no +udgment or estimates is that required for income ta purposes under .(1=%. ,e stress that different depreciation methods are t&picall& used for financial reporting purposes and for income ta purposes. 6 ercise 5 and 1ase 3 emphasize these points. 7roblem 3 is a comprehensive revie$ of the differences among depreciation methods. #n discussing intangible assets, $e place greater emphasis upon the limitations of financial reporting than upon simple mechanics such as amortization over C2 &ears. #nformed users of financial statements should recognize that a business ma& have intangible assets of immense economic value $hich do not even appear on the balance sheet, either because the& $ere developed internall& or because the& have long since been amortized. 6 amples include the 1oca'1ola trademar* and the brand names HKleene H and H%cotch Tape.H 8n the other hand, the presence of an intangible on the balance sheet merel& means that a cost $as incurred, not that an asset necessaril& e ists. This is especiall& true of good$ill, an HassetH for $hich man& companies greatl& overpaid in the 1FE2s $ave of corporate ta*eovers. This point is made in 4iscussion Juestion 20, $hich $e al$a&s revie$ in class. 1aution: #n discussing such issues as differences bet$een recorded values and economic values, $e consider it important not to do$npla& the relevance and usefulness of financial statements. (ctuall&, financial statements and the related disclosures provide an informed reader $ith man& clues as to resources $hich ma& have economic values significantl& different from the recorded amounts. .an& accounting numbers should not be ta*en at face valueI the informed decision ma*ers should loo* to the accounting policies and facts $hich underlie the numbers. ,e vie$ accounting for natural resources and depletion as optional topics in the introductor& accounting course. )asicall&, these topics consist of appl&ing units'of'output depreciation $ithin a specific industr& setting. #f the topic is discussed in class, $e $ould stress the difficult& in estimating the original quantit& of the natural resource at the site. These estimates are made b& professional geologists and other specialists $ith e pertise in fields other than accounting.

Supplemental Exercises Business Week Exercise

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#n :0o$ .uch #s the /ood$ill ,orth<;, &usiness 'ee%, %eptember 1G, 2222, the author suggests that corporate (merican $ill slash at least L322 billion in shareholder equit& from its collective balance sheet and discusses ho$ companies account for an asset called good$ill. =search the recent changes in ho$ M% accountants deal $ith good$ill to see ho$ these changes affect the income statement and the balance sheet.

Group Exercise
(ccess the #nternal =evenue $ebsite $$$.irs.gov and search for .(1=% Tables. 1hoose one column from the .(1=% table for 3'&ear propert& using the half'&ear convention. 7repare a presentation for the class demonstrating ho$ the percentage allo$ances for depreciation in this table $ere determined.

nternet Exercise
Obtain Exxon Mobils mos t rece n t ann u al report from the com p a n y websit e www.exxo n m o bil.co m Rese a r c h the footno t e s , balanc e she e t , and incom e stat e m e n t and describ e the inform a tio n you find reg ar din g depletion.

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CHAPTER 9 10- MINUTE QUIZ A

NAME SECTION

Indicate the best answer for each question in the spac e provided. Use th e follo w i n g da t a for qu e s t i o n s 1 an d 2. On March 12, 2005, Trio, Inc. acquired melting equipm e n t for $37,000. The estim at e d life of the equipm e n t is 7 years, with an estim a t e d residual value of $9,000. 1 Ref e r to ab o v e da t a . In its financial state m e n t s , Trio uses straight- line depr eciation with the half- year convention. The bo o k valu e of the equipm e n t at Dece m b e r 31, 2006, will be: a $29,000. b $35,000. c $31,000. d Some other

amount. 2 Ref e r to ab o v e da t a . In its financial state m e n t s , Trio uses double- declining- balanc e depreciation with half- year convention. The bo o k valu e of the equipm e n t at Dece m b e r 31, 2006, will be: a $21,035. b $23,286. c $22,653. d Some other

amount. 3 Koo Dairy sold a delivery truck for cash of $6,400. The original cost of the truck was $26,000, and a loss of $4,000 was recognize d on the sale. The acc u m u l a t e d de p r e c i a t i o n at the date of sale must have been: a $19,600. b $10,400. c $2,400. d $15,600. Doug Corporation purcha s e s Leslie Compa nys entire busine s s for $3,200,00 0. The fair marke t value of Leslies net identifiable asset s is $2,900,000. a Leslie should record goodwill of $300,000. b Doug paid $300,000 for goodwill gener a t e d by Leslie. c Doug should charge the $300,000 exces s paid for Leslie Company directly to expe ns e . d Leslie should record amortization over a period not to exce e d 40 years. Throughout the current year, Horison Company treat e d sales taxes paid on purchas e s of plant asse t s as revenu e expenditure s. As a result, the current years: a Net incom e is overst a t e d. b Revenu e is overst at e d . c Depreciation expe ns e is underst a t e d. d None of the above; paym e n t s of sales taxes sh o u l d be treat e d as revenu e expenditure s.

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CHAPTER 9 10- MINUTE QUIZ B

NAME SECTION

Indicate the best answer for each question in the spac e provided. Use th e whic h follo w : follo w i n g da t a for th e four ind e p e n d e n t qu e s t i o n s

On May 5, 2005, Central purcha s e d a machine for $74,000. The estim at e d life of the machine was 10 years, with an estim a t e d residual value of $10,000. The service life in term s of output is estim a t e d at 8,000 hours of operation. 1 Ref e r to th e ab o v e da t a . Assum e Central uses str ai g h t - line depreciation with the half- year convention. Depreciation expen s e to be recognized in 20 0 5 (the year of purcha s e) is: a $6,400. b $7,400. c $3,200. d Some other

amount. 2 Ref e r to th e da t a ab o v e . Assum e Central uses 200%- decliningbalance depreciation with the half- year convention. Depreciation expens e to be recognize d in 20 0 6 (the second year of ownership) is: a $7,400. b $11,840. c $13,320. d Some other

amount. 3 Ref e r to th e da t a ab o v e . Assum e Central uses 15 0 % -decliningbalance depreciation with the half- year convention. Depreciation expens e to be recognized in 20 0 5 (the year of purcha s e) is: a $7,400. b $5,550. c $11,000. d Some other

amount. 4 Ref e r to th e da t a ab o v e . Assum e Central uses the units- ofoutput method, and that the machine was in operation for 1,000 hours in 2005 and 1,800 hours in 2006. The bo o k valu e of the machine at Dece m b e r 31, 20 0 6 , is: a $22,400. b $51,600. c $25,900. d Some other

amount.

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CHAPTER 9 10- MINUTE QUIZ C

NAME SECTION

On April 8, 2006, Adventur e City purcha s e d a Ferris wheel for $200,000. The estim at e d life of the Ferris wheel was 10 years, with an estim at e d residual value of $40,000. The service life in term s of output is estim a t e d at 20,000 hours of operation. Comput e the depreciation on this Ferris wheel in 2006 and 2007 using the following methods . 20 0 6 $________ 20 0 7 $________

Straight- line (with half- year convention)

b 200%- declining- balance (with half- year convention) $________

$________

c 150%- declining- balance (with half- year convention) $________

$________

Units- of-output method (hours of operation: (1,200 in 2006, 2,500 in 2007) $________

$________

Straight- line (with depreciation calculat e d to the neare st whole month) $________

$________

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CHAPTER 9 10- MINUTE QUIZ D

NAME SECTION

Equus Farms, a breed er of racehors e s , paid $324,000 cash for a prize- winning stallion on January 1, 2000. The stallion is depreciat e d on a straight- line basis, with depreciation for partial years rounde d to the near e s t month. Estimat e d useful life was nine years, with no residual value. After owning the animal for six years and five months, Equus Farms sold the stallion on May 31, 2006, for cash of $75,000. Depreciation had last been recorde d on Dece m b e r 31, 2005. a Comput e to the neare s t full month depreciation for the fractional period from January 1, 2006 to May 31 of 2006. $______________ b Comput e the book value of the stallion at May 31, 2006, the date of sale. $______________ the gain or loss on the sale of the stallion. $______________

c Comput e (gain/loss) d

In the space provided below, prepar e the journal entry to record the sale of the stallion on May 31, 2006. (Use Breeding Stock as the title of the ass et account. Assum e that depreciation to date of sale alrea dy has been recorded.) 20 0 6 May 31 Gen e r a l Journal

Com p u t a t i o n s

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SOLUTIONS TO CHAPTER 9 QUIZ A 1 C 2 C 3 D 4 B 5 C QUIZ C QUIZ B 1 C 2 C 3 B 4 B

10- MINUTE QUIZZES

Year 1 2 a Straight- line Year 1: [($200,00 0 - $40,000) x 1/10 x 1/2] Year 2: ($160,00 0 x 1/10) $ 8,000

Year

$16,000

b 200%- declining- balance $36,000 Year 1: ($200,000 x 20% x 1/2) Year 2: [($200,00 0 - $20,000) x 20%] c 150%- declining- balance $27,750 Year 1: ($200,000 x 15% x 1/2) Year 2: [($200,00 0 - $15,000) x 15%] d Units- of-output $ 9,600 Year 1: [($200,00 0 - $40,000) x 1,200/20,00 0] Year 2: [($200,00 0 - $40,000) x 2,500/20,00 0] Straight- line $ 12,000 Year 1: [($200,00 0 - $40,000) x 1/10 x 9/12] Year 2: ($200,000 - $40,000) x 1/10

$20,000

$ 15,000

$20,000

$ 16,000

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QUIZ D a $15,000 b $93,000 c $18,000 loss d Year 20 0 6 May 31

Gen e r a l Journal 18,000 75,000 231,000 324,000

Loss on Sale of Breeding Stock Cash Accumulat e d Depreciation, Breeding Stock Breeding Stock To record sale of stallion at price below book value.

Com p u t a t i o n s a Depreciation for the five mont hs ende d May 31, 2006 [($324,00 0 cost 9 years) x 5/12] ................................. Book value of the stallion at May 31, 2006: Original cost .................................................................. Depreciation for 6 years (year 1 through year 6) ($324,00 0 9) x 6 years .......................................... $216,000 Depreciation for 5 mont hs in year 7 (see part a ) Accumulat e d depreciation to May 31, 2002 ..... Book value of stallion at May 31, 2002 ..... Loss on sale of the stallion: Sales price $75,000 - $93,000 book value ........

$ 15,000

$324,000

15,000 (231,000) $ 93,000

$ 18,000 loss

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