Lecture Accounting: What the numbers mean (5/e) - Chapter 6: Accounting for and presentation of property, plant, and equipment, and other noncurrent assets

After reading this chapter, you should be able to answer the following questions: How are the costs of land, buildings, and equipment reported on the balance sheet? How are the terms capitalize and expense used with respect to property, plant, and equipment? What are the alternative methods of calculating depreciation for financial accounting purposes, and what are the relative effects of each on the income statement (depreciation expense) and the balance sheet (accumulated depreciation)?...

CHAPTER 6

ACCOUNTING FOR AND

PRESENTATION OF PROPERTY, PLANT, AND

EQUIPMENT, AND OTHER

NONCURRENT ASSETS

Learning Objectives

1 How are the costs of land, buildings, and

equipment reported on the balance

sheet?

2 How are the terms capitalize and expense

used with respect to property, plant, and

equipment?

3 What are the alternative methods of

calculating depreciation for financial

accounting purposes, and what are the

relative effects of each on the income

statement (depreciation expense) and the

Learning Objectives

4 Why is depreciation for income tax

purposes an important concern of tax-

payers, and how does tax depreciation

differ from financial accounting

depreciation?

5 What is the accounting treatment of

maintenance and repair expenditures?

6 What is the effect on the financial

statements of the disposition of noncurrent assets either by abandonment or sale?

7 What is the difference between and

operating lease and a capital lease?

Learning Objectives

8 What are the similarities in the financial

statement effects of buying an asset

compared to using a capital lease to

acquire the rights to an asset?

9 What are the meanings of various

intangible assets, how are their values

measured, and how are their costs

reflected in the income statement?

10 What is the role of present value concepts

in financial reporting, and what is their

Learning Objective 1

• How are the costs of land,

buildings, and equipment reported

on the balance sheet?

• Shown on the balance sheet at its original

cost

• Cost includes all ordinary and necessary

items to get the land ready for its intended

use

• Land acquired for investment or potential

future use is classified as a noncurrent,

nonoperating asset

• Land is not depreciated

• Gains and losses on the sale of land are

Learning Objective 2

• How are the terms capitalize and

expense used with respect to

property, plant, and equipment?

• Expenditures should be capitalized if the item

acquired will have an economic benefit beyond the current fiscal year

• Capitalized assets – except land – are

depreciated

• Depreciation expense is recognized over the

useful life of the asset

• Materiality concept is applied to capitalization

• Accounting judgment plays a role in

• Expenditures should be expensed if the

item acquired will not have an economic

benefit beyond the current fiscal year

• Expenditures for preventive

maintenance are expensed

• Items are expensed if their costs are not

material, even if they have a useful life of several years

Learning Objective 1

• How are the costs of land,

buildings, and equipment reported

on the balance sheet?

Buildings and Equipment

• Recorded at original cost

• Cost includes all ordinary and necessary

costs to get the asset ready to use

• Interest costs associated with the loans used

to finance construction are capitalized until

the building is put in operation

• Installation costs and shake-down costs are

capitalized

• Self-manufactured asset cost includes

materials, labor, and overhead costs

Basket Purchase Allocation

• When two or more items are purchased

in a single transaction, the cost of each

asset must be determined

• The allocation of the purchase price is

made based on the relative appraisal

values of each asset to the total

• See Exhibit 6-2 in text

Depreciation for Financial

Accounting Purposes

• An application of the matching concept

since an asset is a prepaid cost

• A portion of the cost should be

subtracted from the revenues that are

generated through the use of the asset

• Depreciation is the allocation of the cost

of an asset to the time periods

benefited

Depreciation Details

• The balance in the Accumulated

Depreciation account is the cumulative

total of all depreciation expense

recorded over the life of the asset

• Net book value is the cost of the asset

less the accumulated depreciation

• Note: cash is not involved in the

depreciation entry

Learning Objective 3

• What are the alternative methods of

calculating depreciation for financial

accounting purposes, and what are the relative effects of each on the income

statement (depreciation expense) and

the balance sheet (accumulated

depreciation)?

Depreciation Methods

• Accelerated depreciation results in

greater depreciation expense and lower

net income during the early years of an

asset’s life

• Straight-line depreciation results in

even amounts of depreciation being

taken over the life of the asset

Straight-Line Depreciation

• Annual amount of depreciation is

calculated as follows:

Cost – Estimated salvage value

Estimated useful life

• The same amount of depreciation

expense is taken each year

Units-of-Production Depreciation

• The depreciation expense per unit

produced is calculated as follows:

Cost – Estimated salvage value

Estimated total units to be made

• The depreciation expense for the period

is calculated by multiplying the number

of units produced that period times

the depreciation expense

Sum-of-the-Years’ Digits

Depreciation

• Annual depreciation expense is calculated

as follows:

(Cost – Estimated salvage value) x

Remaining life in years

Sum-of-the-years’ digits

• Results in greater depreciation

expense earlier in the life

of the asset

• Greater depreciation expense is

taken earlier in the life of the asset

Learning Objective 4

• Why is depreciation for income tax

purposes an important concern of

taxpayers, and how does tax

depreciation differ from financial

accounting depreciation?

Depreciation Expense for Income Tax Purposes

• Depreciation is a deductible expense for income tax purposes

• In 1981, ACRS was placed in use

• In 1986, MACRS lengthened the lives of the

assets for depreciation purposes and additional categories were added

• Most firms do not use income tax depreciation

methods for financial reporting purposes – tax

Learning Objective 5

• What is the accounting

treatment of maintenance and repair expenditures?

Maintenance and Repair

Expenditures

• Preventative maintenance expenditures

and routine repair costs are expenses

of the period in which they were

incurred

• If a maintenance expenditure will

extend the useful life or salvage value

of an asset beyond that originally used

Learning Objective 6

• What is the effect on the financial

statements of the disposition of noncurrent assets either by abandonment or sale?

Disposal of Depreciable Assets

• When a depreciable asset is sold or scrapped,

both the asset and the related accumulated

depreciation account must be reduced by the

appropriate amounts

• If net book value is greater than amount received,

a loss will result

• If net book value is less than the amount received,

a gain will result

Learning Objective 7

• What is the difference between

and operating lease and a capital

lease?

Assets Acquired by

Capital Lease

• Operating lease – just the use of the

asset; does not involve any attributes of

ownership

• Capital lease (financing lease) – lessee

(renter) assumes all of the risks and

benefits of ownership

Capital Lease Criteria

• A lease is categorized as a capital lease if

any of the following apply:

– The lease transfers ownership of the asset

to the lessee

– The lease permits the lessee to purchase

the asset at a nominal price at the end of

the lease

– The lease term is at least 75% of the

asset’s economic life

– The present value of the lease payments is

at least 90% of the fair value of the asset

Learning Objective 8

• What are the similarities in the

financial statement effects of

buying an asset compared to

using a capital lease to acquire

the rights to an asset?

Similarities of Buying

and Leasing

• Before the FASB lease standard was issued

in 1976, many capital leases were not

reported in the financial statements

• Leases not appearing on financial statements

is called off-balance-sheet financing

• Now both the asset and the related liability

are reported on the balance sheet

Lease Transactions

• A lease payment reduces cash, reduces

the lease liability, and increases interest

Learning Objective 9

• What are the meanings of

various intangible assets, how are their values measured, and how are their costs reflected in the income statement?

Intangible Assets

• Long-lived assets that are represented

by a contractual right or result from a

purchase transaction

• Is not physically identifiable

• Are amortized – the process of

allocating the cost of the intangible

asset to expense over time

Examples of Intangible Assets

• Leasehold improvements – modification

expenses for leased spaces

• Patents – licenses granted by the

government giving the control of the use

or sale of an invention for a period of 17

years

• Trademarks – registered with the Federal

Trade Commission for

an unlimited life

More Examples of Intangible

Assets

• Copyrights – protections granted to

writers and artists to prevent unauthorized copying of a work The protection is

granted for the life of the artist or writer

Natural Resources

• Consist of coal deposits, crude oil

reserves, timber, mineral deposits , etc

• The using up of the natural resource is

called depletion

– The concept of depletion is similar to

depreciation, only more complicated

– Usually computed on a

straight-line basis

Other Noncurrent Assets

• Long-term investments

• Notes receivable that are due more

than one year in the future

• Are reclassified as they become current

(receivable within a year)

Learning Objective 10

• What is the role of present value

concepts in financial reporting,

and what is their usefulness in

decision making?

Present Value

• An application of compound interest – the process of earning interest on interest

• Involves determining the present amount

that is equivalent to an amount to be paid

or received in the future

• Recognizes that money does have value

over time

• The interest rate is called the discount rate

Present Value Calculations

• Can use for events that consist of a single payment or a series of payments (called an annuity)

• Formulas and computer programs and

calculators can calculate present value

• The appendix demonstrates how to

calculate present value using tables

containing present value factors