Long-Lived Assets

An Asset that will provide benefits for more than one year
Tangible Assets: Property, Plant, and Equipment
Intangible Assets: Goodwill, Brand Names, Patents, Customer Lists
Accounting issues
Acquisition cost
Depreciation and amortization
Ongoing costs
Disposals
Impairments
KNOWLEDGE FOR ACTION

Capitalizing vs. Expensing

Capitalizing
When costs incurred (yr 1)
Dr. Asset 100
Cr. Cash or payable 100
Future entries (yr 1
Dr. Expense 10
Cr. Asset 10

yr 10)

Total expense over 10 years = 100

Expensing
When costs incurred (yr 1)
Dr. Expense 100
Cr. Cash or payable 100
Future entries (yr 1
No entry

yr 10)

Total expense over 10 years = 100

KNOWLEDGE FOR ACTION

Acquisition Costs for Long-Lived Assets

Capitalize all costs necessary to get an asset ready for its intended
use (e.g., purchase price, delivery charges, installation costs, etc.)
For self-constructed assets, also capitalize interest on debt that is
incurred to finance the asset s construction
In this case, interest expense on the income statement does not reflect all of t
he
interest costs incurred by the firm
If acquisition costs include multiple classes of assets (e.g. land,
building, and machinery), the cost must be allocated into separate
asset classes
KNOWLEDGE FOR ACTION

Example
Bott Inc. builds a new piece of equipment to put grips on golf clubs.
Bott spends $4,500 cash on raw materials and $3,000 cash on labor.
Bott incurs $500 of interest costs (interest payable) to finance the
building of the equipment
(1) Dr. Equipment (+A)
Cr. Cash (-A)
Cr. Interest Payable (+L)
8000
7500
500
Equipment (A)
(1)
8000
KNOWLEDGE FOR ACTION

Depreciation and Amortization

Terminology
Tangible assets (Buildings and equipment) are depreciated
Intangible assets (Patents, Software) are amortized
Elements of depreciation calculations
Depreciable basis (acquisition cost
salvage value)
Useful life (years or units)
Depreciation pattern (straight-line or accelerated)
All of these elements are chosen by management
KNOWLEDGE FOR ACTION

Depreciation Methods
Straight line (most common in financial statements)
Depreciation Expense = (Acquisition Cost
Salvage Value) / Useful life
Accelerated (almost never used in financial statements)
Double declining balance
Depreciation exp = (Cost
Acm. Depr.) * (2 / Useful life)
Sum-of-the-Years digits
Depreciation exp = (Cost
Salvage) * (Remaining life / Sum-of-the-Years Digits)
MACRS (required in U.S. tax returns)
Call your tax accountant for details
Firms can use different methods for taxes and financial statements
Total depreciation expense is the same over the life of the asset,
regardless of method used
KNOWLEDGE FOR ACTION

Depreciation Patterns
Acquisition Cost
Salvage Value
Net Book Value
Acquisition Years End of
Year
Useful Life
KNOWLEDGE FOR ACTION

Example
Bott management decides that the equipment will have a useful life of
six years with a $2,000 salvage value. Bott must recognize one year
of depreciation using the straight-line method
Annual Depreciation = (Acquisition Cost
Salvage Value) / Useful Life
Annual Depreciation = (8000
2000) / 6
Annual Depreciation = 1000
KNOWLEDGE FOR ACTION

Example
Bott management estimates that 3/4 of the time the equipment was
used to produce golf club inventory; the rest of the time it was used
for the personal clubs of the sales force and top management (which
is a perk that Bott provides these employees)
(2) Dr. Work-in-Process (+A)
750
Dr. Depreciation Expense (+E)
250
Cr. Accumulated Depreciation (+XA) 1000
Equipment (A)
Acm Depreciation (XA)
1000 (2)
(1)
8000
KNOWLEDGE FOR ACTION