LONG-TERM ASSETS

Dr. Michael Shen

© Copy right National Univ ersity of Singapore. All Rights Reserv ed.
 LEARNING OBJECTIVES
❑ Explain the cost principle for long-term assets
❑ Compute and record depreciation using the straight-line, units-of-
production and declining-balance methods
❑ Explain depreciation for partial years, changes in estimates, and
impairment
❑ Distinguish between revenue and capital expenditures
❑ Explain the revaluation model to account for property, plant and
equipment
❑ Account for asset disposal
 LEARNING OBJECTIVE 1
Explain the cost principle for long-term assets
 LONG-TERM OR NONCURRENT ASSETS
Assets not used up within one year or the operating cycle,
whichever is longer

▪ Property, plant and equipment • Intangible Assets

▪ Land • Patents
▪ Building • Copyrights
▪ Machinery and equipment • Franchises and licenses
▪ Other tangible assets • Goodwill
• Trademarks and trade
names
• Other intangible assets
Statements of Financial Position
as at 31 March (S$ millions)
2018 2017
Largest
assets
Profit and Loss Accounts for the year ended 31 March (S$ millions)
2018 2017

3rd largest
expense
 COST DETERMINATION

Acquisition Cost

Purchase price All expenditures needed to

prepare the asset for its
intended use. Costs must
be normal, reasonable and
necessary.
 BUILDINGS
Cost of purchase or Title fees
construction

Brokerage Attorney fees

fees

Taxes
 MACHINERY AND EQUIPMENT

Purchase Sales taxes

price

Transportation
charges

Installing,
assembling, and Insurance while
testing in transit
 LAND
Title insurance premiums
Purchase Delinquent
price taxes

Real estate Surveying

commissions fees

Title search and transfer fees

Land is not depreciable.

 LAND IMPROVEMENTS

Parking lots, driveways, fences, walks, shrubs, and lighting systems

Depreciate
over useful life of
improvements.
 COST DETERMINATION
On Jan 1, Buyer Co., buys a new machine from Supply Co. The
new machine has a price of $52,000. Sales tax is 8%. Buyer
Co. pays $500 shipping cost to get the machine to its factory.
After the machine arrives, set-up costs of $1,300 are incurred,
along with $4,000 in testing costs. During the set-up, an
employee accidentally damaged a small part which needs to be
repaired at $300.

Compute the cost of Buyer Co.’s new machine.

 COST DETERMINATION
List price $ 52,000
Sales tax ($52,000 × 8%) 4,160
Transportation cost 500
Set-up 1,300
Testing 4,000
Total cost to Buyer Co. $ 61,960

Machine 61,960
Cash 61,960

$300 repair is recorded as an expense, because it is not

normal, reasonable and necessary.
 LUMP-SUM ASSET PURCHASE
The total cost of a combined purchase of PPE is separated
on the basis of their relative market values.

CarMax paid $90,000 cash to acquire a group of items consisting of

land appraised at $30,000, land improvements appraised at
$10,000, and a building appraised at $60,000. Appraised values are
estimated market values done by property experts. The $90,000
cost will be allocated on the basis of appraised values as shown:
 LEARNING OBJECTIVE 2
Compute and record depreciation using the straight-line,
units-of-production and declining-balance methods
 DEPRECIATION
Depreciation is the process of allocating the cost of an item
of PPE to expense in the accounting periods benefiting from
its use.

Statement of Financial Position Income Statement

Acquisition Cost
Expense
Cost Allocation
(Unused) (Used)
 DEPRECIATION METHODS
1. Straight-line
2. Units-of-production
3. Double Declining balance - DDB

Assume the following data about a machine that inspects athletic

shoes before packaging. It was bought on Dec. 31, 2010.
IAS 16 Property, plant and equipment:
Residual value: estimated amount that an
entity would currently obtain from disposal of
the asset, after deducting the estimated
costs of disposal, if the asset were already of
the age and in the condition expected at the
end of its useful life.
Useful life: period over which an asset is
expected to be available for use.
STRAIGHT-LINE METHOD
 UNITS-OF-PRODUCTION METHOD

Step 1:
Depreciation = Cost - Residual Value
Per Unit Total Units of Production

Step 2:
Number of Units
Depreciation Depreciation × Produced
=
Expense Per Unit in the Period
 UNITS-OF-PRODUCTION METHOD

Assume that 7,000 units were inspected

during 2011. Depreciation would be
calculated as follows:

Step 1:
Depreciation = Cost - Residual Value = $9,000 = $0.25/unit
Per Unit Total Units of Production 36,000

Step 2:
Number of Units
Depreciation Depreciation = $0.25 × 7,000 = $1,750
× Produced
Expense = Per Unit
in the Period
 UNITS-OF-PRODUCTION
DEPRECIATION SCHEDULE
 DOUBLE-DECLINING-BALANCE METHOD

Note that for double-declining-balance method (DDB), the

residual value is NOT deducted in the beginning amount.
 DOUBLE-DECLINING-BALANCE METHOD

Note that the residual value is NOT deducted in the beginning

amount.

Statement of Financial Position Presentation

Machinery $ 10,000
Less: accumulated depreciation 4,000 $ 6,000
 DOUBLE-DECLINING-BALANCE METHOD

Statement of Financial Position Presentation

Machinery $ 10,000
Less: accumulated depreciation 6,400 $ 3,600
 DOUBLE-DECLINING-BALANCE METHOD

In 2015, if we take 40% of $1,296, then we get $518.4, which will reduce
carrying amount to less than residual value. Since we can never depreciate
carrying amounts to below residual values, we must compute
depreciation expense so that carrying amount equals residual value.
Therefore, the depreciation expense is computed as $1,296 - $1,000 = $296
 COMPARING DEPRECIATION METHODS
In 2011, DDB gives the highest expense, which results in the
lowest profit

Double- $4,000
Straight- Units of Declining- $3,500
Period Line Production Balance $3,000
2011 $ 1,800 $ 1,750 $ 4,000 $2,500
2012 1,800 2,000 2,400 $2,000
2013 1,800 2,250 1,440 $1,500

2014 1,800 1,750 864 $1,000

2015 1,800 1,250 296 $500

Totals $ 9,000 $ 9,000 $ 9,000 $-

2011 2012 2013 2014 2015

Straight-Line Units-of-Production Double-Declining-Balance

THE RELATIONSHIP BETWEEN DEPRECIATION AND INCOME TAXES

▪ Which depreciation method should a company use to minimize income

taxes paid?
▪ Choose method which results in largest depreciation expense: An
accelerated method such as Double-Declining-Balance.

$4,000

$3,500

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$-
2011 2012 2013 2014 2015

Straight-Line Double-Declining-Balance
THE RELATIONSHIP BETWEEN DEPRECIATION AND INCOME TAXES

▪ Larger depreciation expense early in asset’s life decreases profit.

▪ Assuming that the profit is also used by tax authorities, the income
taxes will be minimized.
▪ Allows company to put excess cash to work:
▪ Short-term investments
▪ Inventory
▪ Marketing campaigns
▪ Expansion plans
 LEARNING OBJECTIVE 3
Explain depreciation for partial years, changes
in estimates and impairment
 PARTIAL-YEAR DEPRECIATION
When an item of PPE is acquired during the year, depreciation is calculated
for the fraction of the year the asset is owned.
Cost $ 10,000 Assume the machinery was purchased on
October 8, 2010. For calculation using
Residual value 1,000 straight-line method, we assume that the asset
Depreciable cost $ 9,000 is purchased on the first day of the month
Useful life nearest the actual date of purchase.
Accounting periods 5 years October to December = 3 months:
Units inspected 36,000 units
 CHANGE IN ESTIMATES FOR DEPRECIATION

Estimated Estimated
residual value useful life

Depreciation
is an estimate

▪ Over the life of an asset, new information may come to light that
indicates the original estimates were inaccurate.
▪ IAS 16: The residual value and the useful life of an asset shall be
reviewed at least at each financial year-end and, if expectations differ
from previous estimates, the change(s) shall be accounted for as a
change in an accounting estimate.
 CHANGE IN ESTIMATES FOR DEPRECIATION
From the previous example, at the beginning of the
machine’s third year, its carrying amount is $6,400
($10,000 cost less $3,600 accumulated depreciation
using straight-line depreciation). At that time, it is
determined that the machine will have a remaining useful
life of 4 years, and the estimated residual value will be
revised downward from $1,000 to $400.
 IMPAIRMENT OF PPE
▪ An asset is impaired when a company is not able to recover the asset’s
carrying amount either through using it or by selling it
▪ E.g. A company has specialized machines that can manufacture only DVDs. These
machines will be useless once the market switches completely to Blu-ray discs. These
machines have to be tested for impairment losses (details in advanced accounting
courses)

▪ Journal Entry:
Dr Impairment Loss - Machinery
Cr Accumulated Depreciation & Impairment Loss - Machinery
 LEARNING OBJECTIVE 4
Distinguish between revenue expenditure
and capital expenditure
 ADDITIONAL EXPENDITURES

After a company acquires an item of PPE and puts it into

service, it often makes additional expenditures for that
asset’s operation, maintenance, repair, and improvement

Capital Revenue
Expenditure Expenditure
CAPITAL EXPENDITURES VS. REVENUE EXPENDITURES

Capital Revenue
Expenditure Expenditure

Any material expenditure Expenditure for

that will benefit several ordinary repairs
accounting periods and maintenance

To capitalize an expenditure To expense an expenditure

means to record it in an means to record it in an
asset account expense account
 CAPITAL EXPENDITURES VS. REVENUE EXPENDITURES

Suppose a company pays $8,000 for a machine with an eight-

year useful life and no residual value. After three years and
$3,000 of depreciation, it adds an automated control system to
the machine at a cost of $1,800. This results in reduced labor
costs in future periods.

This is a capital expenditure and the journal entry is:

 LEARNING OBJECTIVE 5
Explain the revaluation model to account for
property, plant and equipment
 SUBSEQUENT MEASUREMENT MODELS

Initial Cost
recording

OR

After Cost Revaluation

recording
 SUBSEQUENT MEASUREMENT MODELS
The Cost Model states that after recognition as an asset, an
item of PPE shall be carried at its cost less any accumulated
depreciation and any accumulated impairment losses.

The Revaluation Model states that after recognition as an

asset, an item of PPE whose fair value can be measured
reliably shall be carried at a revalued amount, being its fair
value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated
impairment losses. The fair value of PPE is usually
determined from market-based evidence by professional
appraisal or valuation.
 REVALUATION MODEL
If land which was bought for $1 million in 2010 is revalued to
$1.5 million on June 30, 2012 (no depreciation for land), the
journal entry for the revaluation on that date is:

Revaluation surplus or reserve is part of other comprehensive income to be

elaborated in lecture topic “Income and Equity”.

Revaluation for depreciable assets such as machinery not covered in this course.
LEARNING OBJECTIVE 6
Account for asset disposal
 DISPOSALS OF PPE
▪ Business might dispose of PPE any time.
▪ Discard
▪ Sell
▪ Steps in accounting for disposals:
1. Record depreciation up to the date of disposal—this also
updates Accumulated Depreciation.
2. Record the removal of the disposed asset’s account
balances—including its Accumulated Depreciation.
3. Record any cash (and/or other assets) received.
4. Record any gain or loss.
 GAINS OR LOSSES ON DISPOSALS OF PPE
▪ Disposal Update
Amountdepreciation
> Carrying Amount, record
to the date of disposal.
a gain (credit).
▪ Disposal Amount < Carrying Amount, record
a loss (debit).
▪ Disposal Amount = Carrying Amount, no gain
or loss.

Such gains or losses affect the bottom line (net profit or

net loss) of the company.
 SELLING PPE: NO GAIN OR LOSS
On March 31, BTO sells equipment that originally cost $16,000 and has
accumulated depreciation of $12,000 at December 31 of the prior
calendar year-end. Annual depreciation on this equipment is $4,000 using
straight-line depreciation. The equipment is sold for $3,000 cash.
Step 1: Update depreciation to March 31.

Step 2: Record sale of asset at carrying amount ($16,000 - $13,000 = $3,000).

Disposal Amount $3,000 = Carrying Amount $3,000

No gain or loss
On March 31, BTO S ELLING
sells PPE
equipment AT A Gcost
that originally AIN$16,000 and has
accumulated depreciation of $12,000 at December 31 of the prior
calendar year-end. Annual depreciation on this equipment is $4,000 using
straight-line depreciation. The equipment is sold for $7,000 cash.
Step 1: Update depreciation to March 31

Step 2: Record sale of asset at a gain (Cash received $7,000 – carrying amount
$3,000).

Disposal Amount $7,000 > Carrying Amount $3,000

Gain of $4,000
On March 31, BTO S ELLING
sells PPE
equipment AT A Lcost
that originally OSS$16,000 and has
accumulated depreciation of $12,000 at December 31 of the prior
calendar year-end. Annual depreciation on this equipment is $4,000 using
straight-line depreciation. The equipment is sold for $2,500 cash.
Step 1: Update depreciation to March 31.

Step 2: Record sale of asset at a loss (Carrying amount $3,000 - $2,500 cash
received).

Disposal Amount $2,500 < Carrying Amount $3,000

Loss of $500
 Revenues
- Expenses
+ Gains
- Losses
= Net Profit

SIA called a “surplus”

instead of a “gain”.
THE END