Chapter 8

LLH 11ed

Reporting and Interpreting

Property, Plant, and Equipment;
Natural Resources; and
Intangibles
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Understanding The Business

1) Companies must forecast PPE needs long
into the future because changes are very
costly.
2) The infrastructure must be in place to
operate efficiently

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Classifying Long-Lived Assets

Actively Used in Operations

Expected to Benefit Future Periods

Tangible Intangible
Physical No Physical
Substance Substance
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Classifying Long-Lived Assets

Actively Used in Operations
Examples
Land

Expected to Benefit Future
 Assets subject Periods
to depreciation
 Buildings and equipment

 Furniture and fixtures

 Natural resource assets

subject to depletion
Tangible Intangible
 Mineral deposits and timber

Physical No Physical
Substance Substance
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Classifying Long-Lived Assets

Actively Used in Operations
Examples
 Value represented by rights
thatExpected to Benefit
produce benefits Future Periods
Patents
Copyrights
Trademarks
Franchises
Tangible
Goodwill Intangible
 Subject to amortization
Physical No Physical
Substance Substance
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FedEx
1) The next three slides present the
financial data for FedEx from their 10-K
(2020)
2) The first two slides are their balance
sheet (assets and then Liabilities and
equities). The third slide is their Income
statement.

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Fixed Asset Turnover

Fixed
Net Sales Revenue
Asset =
Turnover Average Net Fixed Assets

For the year 2020, FedEx had $69,217 of

revenue. End-of-year fixed assets were $33,608
and beginning-of-year fixed assets were $30,429.
(All numbers in millions.)

This ratio measures a company’s ability

to generate sales given an investment in
fixed assets.
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Fixed Asset Turnover

Fixed
Net Sales Revenue
Asset =
Turnover Average Net Fixed Assets

Fixed
$69,217
Asset = = 2.162
Turnover ($33,608 + $30,429) ÷ 2

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Measuring and Recording

Acquisition Cost
1) Acquisition cost includes the purchase
price and all expenditures needed to
prepare the asset for its intended use.
2) Acquisition cost does not include
financing charges and cash discounts.

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Acquisition Cost
Buildings
1. Purchase price
2. Architectural fees
3. Cost of permits
4. Excavation costs
5. Construction costs

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Acquisition Cost
Equipment
1. Purchase price
2. Installation costs
3. Modification to building
necessary to install equipment
4. Transportation costs

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Acquisition Cost
Land
1. Purchase price
2. Real estate commissions
3. Title insurance premiums
4. Delinquent taxes
5. Surveying fees
6. Title search and transfer fees

Land is not depreciable.

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Acquisition for Cash

Suppose that on June 1, FedEx purchased
aircraft for $70,000,000 cash.

The flight equipment account would be increased by

$70,000,000 and the cash account would decrease by
the same amount.

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Acquisition for Debt

Suppose, instead that on June 14,
FedEx purchased
aircraft for $1,000,000 cash and a
$69,000,000 note payable.

The flight equipment account (a non-current asset called

property and equipment) would increase by $70 Million,
the cash account (a current asset) would decrease by $1
Million, and the liability, Notes Payable, would increase
by $69 Million.

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Acquisition for
Noncash Consideration
Record at the current market value of
the consideration given, or the current
market value of the asset acquired,
whichever is more clearly evident.

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Acquisition for
Noncash Consideration
On July 7, FedEx gave Boeing 6,000,000 shares of $1.50 par
value common stock with a market value of $7 per share plus
$28,000,000 in cash for aircraft.

The flight equipment account would increase by $70

Million, the cash account (a current asset) would
decrease by $28 Million, Common stock would increase
by $9 Million, and Paid-in-Capital in excess of par would
increase by the remaining $33 Million.

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Acquisition by Construction
1) Asset cost includes:All materials and labor
traceable to the construction.

2) A reasonable amount of overhead.

3) Interest on debt incurred during the

construction.

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Repairs, Maintenance,
and Additions

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Capital and Revenue

Expenditures

Many companies have policies expensing all

expenditures below a certain amount according to
the materiality constraint.
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Depreciation

Depreciation is a cost allocation process that

systematically and rationally matches
acquisition costs of operational assets with
periods benefited by their use.

Balance Sheet Income Statement

Cost
Undepreciated
Expense
Cost Allocation

(Unused) (Used)
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Depreciation
Depreciation Depreciation for Income
Expense the current year Statement

Accumulated Total of depreciation Balance

Depreciation to date on an asset Sheet

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Depreciation on the FedEx

2020 Balance Sheet

Book value ≠ Market value

Book Value
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Depreciation Concepts
The calculation of depreciation requires
three amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.

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Alternative Depreciation
Methods

 Straight-line
 Units-of-production
 Accelerated Method:
Declining balance

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Straight-Line Method
Depreciation Cost - Residual Value
=
Expense per Year Life in Years

Suppose that at the beginning of the year, FedEx

purchased equipment for $62,500 cash. The
equipment has an estimated useful life of 3 years
and an estimated residual value of $2,500.

SL

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Straight-Line Method
Depreciation Cost - Residual Value
=
Expense per Year Life in Years

Depreciation $62,500 - $2,500

=
Expense per Year 3 years

Depreciation
= $20,000
Expense per Year

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Straight-Line Method

Residual Value

More than 95 percent of companies use the straight-

line method for some or all of their
assets disclosed in financial reports.

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Units-of-Production Method
Step 1:

Depreciation Cost - Residual Value

=
Rate Life in Units of Production

Step 2:
Number of Units
Depreciation Depreciation
= X Produced
Expense Rate
for the Year

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Units-of-Production Method
At the beginning of the year, FedEx purchased ground
equipment for $62,500 cash. The equipment has a
100,000 mile useful life and an estimated residual
value of $2,500.

If the equipment is used 30,000 miles in the first

year, what is the amount of depreciation expense?

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Units-of-Production Method
Step 1:

Depreciation $62,500 - $2,500

= = $.60 per mile
Rate 100,000 miles

Step 2:

Depreciation
Expense = $.60 per mile X 30,000 miles = $18,000

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Units-of-Production Method

Residual Value

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Accelerated Depreciation
Accelerated depreciation matches higher depreciation
expense with higher revenues in the early years of
an asset’s useful life when the asset is more
efficient.

Depreciation Repair
Expense Expense
Early Years High Low
Later Years Low High
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Double-Declining-Balance
Method
Declining balance rate of 2 is
double-declining-balance (DDB) rate.

Annual Net 2
Depreciation
expense
= Book
Value
X ( Useful Life in Years )

Cost – Accumulated Depreciation

Annual computation ignores residual value.

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Double-Declining-Balance
Method
At the beginning of the year, FedEx purchased
equipment for $62,500 cash. The equipment
has an estimated useful life of 3 years and an
estimated residual value of $2,500.

Calculate the depreciation expense

for the first two years.

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Double-Declining-Balance
Method
Annual Net 2
Depreciation
expense
= Book
Value
X ( Useful Life in Years )
Year 1 Depreciation:
2
$62,500 X ( 3 years )= $41,667

Year 2 Depreciation:
2
($62,500 – $41,667) X ( 3 years )= $13,889

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Double-Declining-Balance
Method

Below residual value

2
($62,500 – $55,556) X ( 3 years ) = $4,629 39
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Double-Declining-Balance
Method

Depreciation expense is limited to the amount that

reduces book value to the estimated residual value.
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Depreciation and
Federal Income Tax
For tax purposes, most corporations use the
Modified Accelerated Cost Recovery System
(MACRS).
MACRS depreciation provides for rapid write-off
of an asset’s cost in order to stimulate new
investment. It is derived from a declining-
balance method.

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Depreciation Methods
in Other Countries
Many countries, including Australia,
Brazil, England, and Mexico, use other
methods such as depreciation based
on the current fair value of assets.

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Asset Impairment
Impairment is the loss of a significant portion
of the utility of an asset through . . .
 Casualty.
 Obsolescence.
 Lack of demand for the asset’s services.

A loss should be recognized when an

asset suffers a permanent impairment.

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Disposal of Property, Plant,

and Equipment
Voluntary disposals:
 Sale
 Trade-in
 Retirement
Involuntary disposals:
 Fire
 Accident

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Disposal of Property, Plant,

and Equipment
1) First you must update the depreciation expense since the
last time it was recognized.
2) Compute the net book value of the PPE by taking the cost
and subtracting the (new) accumulated depreciation
3) Gain or (loss) on disposal is the difference between what
you receive for the goods (possibly a negative number if
you have to pay) and the net book value of the asset.
4) Clearly, if the cash you receive (or the fair value of other
assets received) is greater than the NBV, you have a gain.
Otherwise, you have a loss.

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Disposal of Property, Plant,

and Equipment
FedEx sold flight equipment for $5,000,000 cash in
the middle of its 18th year of use. The flight
equipment originally cost $20,000,000, and was
depreciated using the straight-line method with zero
salvage value and a useful life of 20 years.

Accumulated depreciation was 17,000,000 at the end

of the previous year

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Disposal of Property, Plant,

and Equipment
1) Depreciation Expense each year
$20,000,000 ÷ 20 = $1,000,000 per year
2) Depreciation expense for the current 1/2 year
$1,000,000 ÷ 2 = $500,000
3) Net book value at the time of disposal
$20,000,000 - ($17,000,000+$500,000)=
$2,500,000

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Disposal of Property, Plant,

and Equipment
4) Gain on disposal
$5,000,000 - $2,500,000 = $2,500,000

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Natural Resources

A noncurrent
Extracted from asset presented
the natural at cost less
environment. accumulated
depletion.

Examples: oil, coal, gold

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Natural Resources

Total cost of Total cost is

asset is the cost allocated over
of acquisition, periods benefited
exploration, by means of
and development. depletion.

Depletion is like depreciation.

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Depletion of Natural Resources

Depletion is calculated using the
units-of-production method.

Unit depletion rate is calculated as follows:

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Depletion of Natural Resources

Total depletion cost for a period is:
UNIT NUMBER OF UNITS
DEPLETION X EXTRACTED IN PERIOD
RATE
Cost of
Total goods sold
Inventory
depletion
for sale
cost Unsold
Inventory
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Natural Resources

1. Specialized plant assets may be

required to extract the natural
resource.

2. These assets are recorded in a

separate account and
depreciated.

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Intangible Assets
Noncurrent assets Often provide
without physical exclusive rights
substance. or privileges.

Intangible
Assets

Useful life is Usually acquired

often difficult for operational
to determine. use.
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Intangible Assets

 Goodwill
Record at current  Trademarks
cash equivalent  Patents
cost, including
purchase price,  Copyrights
legal fees, and  Franchises
filing fees.  Leaseholds

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Intangible Assets

 Amortize over shorter of economic life or

legal life, subject to rules specified by
GAAP.
 Use straight-line method.
 Research and development costs are
normally expensed as incurred.

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Intangible Assets
Goodwill
1) Goodwill occurs when one company buys another company
and pays more than the fair market value of the assets
acquired.
2) The idea is that the only reason one company would pay
more for another than the FMV of the assets is that
the company has something to offer so that the
consolidated entity can earn superior profits. This
“extra” value is goodwill.
3) Only purchased goodwill is recognized as an asset. Even
if your company has all of the “goodwill” or earnings
potential in the world, it is not recognized unless there
is a transaction (and then only to the entity that
purchases your company).

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Intangible Assets
Goodwill
1) Goodwill is not amortized because it is
thought to have an indefinite life.
2) Rather it is reviewed each year to see
whether its value has been impaired

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Intangible Assets
Goodwill
Eddy Company paid $1,000,000 to purchase
all of James Company’s assets and assumed
liabilities of $200,000. The acquired assets
were appraised at a fair value of $900,000.

The acquisition cost would be $1 Million, the FMV

of the acquisition is $700,000.

Therefore, goodwill is $300,000

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Intangible Assets
Trademarks
1) A symbol, design, or logo associated
with a business.
2) Internally developed trademarks have
no recorded asset cost.
3) Purchased trademarks are recorded at
cost.

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Intangible Assets
Patents
1) Exclusive right granted by federal
government to sell or manufacture an
invention.
2) Cost is purchase price plus legal cost to
defend.
3) Amortize cost over the shorter of useful
life or 20 years.

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Intangible Assets
Copyrights
1) Exclusive right granted by the federal
government to protect artistic or
intellectual properties.
2) Legal life is life of creator plus 70 years.
3) Amortize cost over the period benefited.

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Intangible Assets
Franchises
1) Legally protected right to sell products
or provide services purchased by
franchisee from franchisor.
2) Purchase price is an intangible
asset that is amortized.

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Intangible Assets
Leaseholds
1) A lease is a contract to use property
granted by lessor to lessee and rights
granted under the lease are called a
leasehold.
2) A leasehold is recorded only if advance
payment is involved. Otherwise periodic
payments are rent expense.

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Intangible Assets
Leasehold Improvements
1) Long-lived alterations made by lessee to
leased property.
2) Leasehold improvements are recorded at cost
and amortized over their useful life.

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End of
Chapter 8

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