Chapter 9

Reporting and Interpreting

Long-Lived Tangible and
Intangible Assets
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This chapter focuses
on the ASSETS that
enable companies
to produce and sell
goods and services.

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 Learning Objectives
1. Define, classify, and explain the nature of long-lived assets.
2. Apply the cost principle to the acquisition of long-lived assets.
3. Apply various depreciation methods as economic benefits are used
up over time.
4. Explain the effect of asset impairment on the financial statements.
5. Analyze the disposal of long-lived tangible assets.
6. Analyze the acquisition, use, and disposal of long-lived intangible
assets.
7. Interpret the fixed asset turnover ratio.
8. Describe factors to consider when comparing companies’ long-
lived assets.
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Define, classify, and
explain the nature of
long-lived assets

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 Definition and Classification
of Long-Lived Assets
Resources owned by a business that enable it to produce
the goods or services that are sold to customers.

Tangible Intangible
Physical Substance No Physical Substance

The existence of most intangible

Land, buildings, machinery, assets is indicated only by legal
vehicles, office equipment, documents that describe their
furniture and fixtures. rights: trademarks, licensing
rights, patents, copyrights
 Cedar Fair’s assets
AT DECEMBER 31
(in millions) 2008 2007
Assets
Current Assets $70 $60
Property and Equipment
Land 320 350
Land Improvement 310 320
Buildings 570 580
Rides and Equipment 1,300 1,270
Construction in Progress 20 30
Property and Equipment, at cost 2,520 2,550
Less: Accumulated Depreciation (720) (610)
Property and Equipment, net 1,800 1,940
Goodwill and Other Intangible Assets 300 390
Other Assets 20 30
Total Assets 2,190 2,420
 Land Improvements
 Sidewalks, pavement, landscaping, fencing, lighting,
and sprinkler systems that are added to improve the
usefulness of land.
Deteriorate over time (whereas land is assumed to last
forever).

Construction in progress
 The cost of constructing new buildings and equipment.
 When construction is finished, these costs are moved
from this account into the building or equipment account
to which they relate.
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Apply the cost principle
to the acquisition of
long-lived assets

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 Acquisition of Tangible Assets
Acquisition cost includes the purchase price and all
reasonable and necessary expenditures made to
acquire and prepare the asset for its intended use.
Recording costs as assets (rather than as an expense)
is called capitalizing the costs.

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 Acquisition Cost
Land Buildings Equipment
Purchase cost Purchase/construction cost Purchase/construction cost
Legal fees Legal fees Sales taxes
Survey fees Appraisal fees Transportation costs
Title search fees Architectural fees Installation costs

Land is not depreciable

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 Acquisition Cost
Basket Purchase
The total cost of a combined
purchase of land and building is
split among the assets in
proportion to the market value of
the assets as a whole.

Cedar Fair pay $10m for a hotel and the land surrounding it.
- It is estimated that the land contributes 40% & the
building contributes 60% of the property’s value.
- CF would report 40% of the total cost as land ($4m) and
the other 60% as buildings ($6m). 11
 Acquisition Cost
Cedar Fair purchased a roller coaster $26 million less a
$1 million discount.
- Paid $125,000 for transportation .
- Paid $625,000 for installation.

The costs to be capitalized for the roller coaster

List price $26,000,000
Less: Discount 1,000,000
Net invoice price 25,000,000 To be recorded in the
Rides and Equipment
Add: Transportation costs 125,000 account
Installation costs 625,000
Total cost of the roller coaster $25,750,000 12
 Acquisition
Cash Purchase
If Cedar Fair PAID CASH for the roller coaster and related
transportation and installation costs, the effects of the transaction
and the journal entry to record these effect would be:

Analyze
Assets = Liabilities + Stockholders' Equity
Cash -25,750,000 =
Rides and Equipment +25,750,000 =

Accounts Debit Credit

Record
Rides and Equipment (+A) 25,750,000
Cash (-A) 25,750,000
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 Acquisition
Credit Purchase
Assume Cedar Fair signed a NOTE PAYABLE for the roller coaster
and PAID CASH for the transportation and installation cost, the
accounting equation effects and journal entry would be:
Analyze
Assets = Liabilities + SE
Cash -750,000 = Note Payable +25,000,000
Rides and Equipment +25,750,000 =

Accounts Debit Credit

Record Rides and Equipment (+A) 25,750,000
Cash (-A) 750,000
Note Payable (+L) 25,000,000
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 Maintenance Costs Incurred
During Time of Use
Type of Accounting
Expenditure Identifying Characteristics Treatment
Ordinary 1. Maintains normal operating condition Expense
repairs and 2. Does not increase productivity
maintenance 3. Does not extend life beyond original
estimate
Extraordinary 1. Major overhauls or partial Capitalize
repairs replacements
2. Extends life beyond original estimate
Additions 1. Increases productivity Capitalize
2. May extend useful life
3. Improvements or expansions

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 Depreciation Expense

Depreciation is the allocation of the cost of long-

lived tangible assets over their productive lives
using a systematic and rational method.

Balance Sheet Income Statement

Acquisition Cost
Expense
Cost Allocation
(Unused) (Used)
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 Depreciation Expense

Depreciation Income
Depreciation for
Expense the current year Statement

Accumulated Balance
Total of depreciation
Depreciation to date on an asset Sheet

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 Depreciation Expense
The effects of $130 of depreciation on the
accounting equation and the journal entry to record
them follow:
Analyze
Assets = Liabilities + SE
Accumulated Depreciation (+xA) -130 = Depreciation Exp. (+E) -130

Accounts Debit Credit

Record Depreciation Expense (+E, -SE) 130
Accumulated Depreciation (+xA, -A) 130

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 Reporting Depreciation
Dec. 31
(in millions) Balance Sheet
2008
Assets
Property and Equipment, at cost $2,520
Less: Accumulated Depreciation (720)
Book (or carrying)
Property and Equipment, net 1,800
value
(in millions) Income Statement 2008 The acquisition
Net Revenues $1,000 cost of an asset
Operation Expenses: less accumulated
Food and Operating Expenses 500 depreciation.
Depreciation Expense 130
Selling, General, and Other 130
Loss on Disposal of Fixed Assets 10
Impairment Losses 90
Total Operating Expenses 860
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Income from Operations 140
 Depreciation Calculations
Depreciation calculations are based on the following three items:

1. Asset cost 2. Residual value 3. Useful life

All the asset’s The estimated amount An estimate of the
capitalized costs, to be recovered at the asset’s useful
including the purchase end of the company’s economic life to the
cost, sales tax, legal estimated useful life of company. It may be
fees, and other costs
an asset. expressed in terms
needed to acquire and
of years or units of
prepare the asset for
use. capacity.

Land is the only tangible asset that’s assumed to have an unlimited

(indefinite)useful life. Because of this, land is not depreciated.
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 Apply various
depreciation methods as
economic benefits are
used up over time

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 Depreciation Methods

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

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 Straight-Line Method
Managers choose the straight-line depreciation method if they
want to report an equal amount of depreciation in each period of
the asset’s estimated useful life.

Depreciation Cost - Residual Value

=
Expense per Year Useful Life

CEDAR FAIR – Acquisition of a New Go-Cart Ride

Cost, purchased on Jan 1, 2010 $62,500
Estimated residual value $2,500
Estimated useful life 3 yrs; 100,000 miles

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 Straight-Line Method
Straight-line INCOME
STATEMENT BALANCE SHEET
(Cost – Residual Value)/Useful Life
Depreciation Accumulated Book
Year Yearly Computation Cost
Expense Depreciation Value
At acquisition $62,500 $0 $62,500
2010 ($62,500 – $2,500)/3 $20,000 62,500 20,000 42,500
2011 ($62,500 – $2,500)/3 20,000 62,500 40,000 22,500
2012 ($62,500 – $2,500)/3 20,000 62,500 60,000 2,500
Total $60,000

1. Depreciation Expense is a constant amount each year. Residual Value

2. Accumulated Depreciation increases by an equal amount
each year.
3. Book Value decrease by the same equal amount each year.
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 Units-of-Production Method
Managers choose the units-of-production depreciation method if
the amount of production varies significantly from period to period.

Depreciation Actual Production this Period

= (Cost – Residual Value) x
Expense Estimated Total Production

CEDAR FAIR – Acquisition of a New Go-Cart Ride

Cost, purchased on Jan 1, 2010 $62,500
Estimated residual value $2,500
Estimated useful life 3 yrs; 100,000 miles
Assume this go-cart was driven 30,000 miles in 2010, 50,000 miles
in 2011, and 20,000 miles in 2012. 25
 Units-of-Production Method
Units-of-Production Method INCOME
STATEMENT BALANCE SHEET

Depreciation Accumulated Book

Year Yearly Computation Cost
Expense Depreciation Value
At acquisition $62,500 $0 $62,500
2010 ($62,500 – $2,500) x (30k/100k) $18,000 62,500 18,000 44,500
2011 ($62,500 – $2,500) x (50k/100k) 30,000 62,500 48,000 14,500
2012 ($62,500 – $2,500) x (20k/100k) 12,000 62,500 60,000 2,500
Total $60,000

The depreciation expense, accumulated

depreciation, and book value vary from period to Residual Value
period, depending on the number of units
produced. 26
 Declining-Balance Method
Managers choose the declining-balance depreciation method if
they want a higher amount of depreciation expense in the early
years of an asset’s life and a lower amount in later years.

Depreciation 2
= (Cost – Accumulated Depreciation) x
Expense Useful Life

Net book value Double the

straight-line
rate

Double-declining-balance depreciation method

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 Declining-Balance Method
Double-declining-balance INCOME
STATEMENT BALANCE SHEET
(Cost – Accumulated Depreciation) x (2/Useful Life)

Depreciation Accumulated Book

Year Yearly Computation Cost
Expense Depreciation Value
At acquisition $62,500 $0 $62,500
2010 ($62,500 – $0) x (2/3) $41,667 62,500 41,667 20,833
2011 ($62,500 – $41,667) x (2/3) 13,889 62,500 55,556 6,944
2012 ($62,500 – $55,556) x (2/3) 4,629 62,500 60,185 2,315
4,444 62,500 60,000 2,500
Total $60,000

Depreciation expense is limited to the amount that Residual Value

reduces book value to the estimated residual value.
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 Summary of Depreciation Methods
The amount of depreciation
expense recorded in each year
of an asset’s life depends on
the method that is used.
The amount of net income
that is reported can vary,
depending on the
depreciation method used.
Different depreciation
methods can be used for
different classes of assets
provided they are used
consistently over time so
that financial statement
users can compare results
across periods.
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 Partial-Year Depreciation Calculations
For periods shorter than a year...
Under straight-line and declining-balance These partial-year
methods, the annual depreciation is multiplied modifications are not
by the fraction of the year for which required in the units-of-
depreciation is being calculated. production method.

Example: Cedar Fair purchased the go-cart ride

on Oct 7, 2010 => it owned the asset for about 3
months till the year ended Dec 31, 2010.

The depreciation for the ride in 2010 would be:

$20,000 x (3/12) = $5,000
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 Tax Depreciation
Most companies use one method of depreciation for reporting to
stockholders and a different method for determining income taxes.

Most companies use the IRS-approved Modified Accelerated Cost

Recovery System (MACRS) to calculate depreciation expense for
their tax returns.

MACRS is similar to the declining-balance method, allowing

companies to deduct larger amount of tax depreciation in the early
years of an asset’s life, thereby stimulate investment in new assets.

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Explain the effect of
asset impairment on
the financial
statements

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 Asset Impairment Losses
 As a result of recording depreciation, an asset’s book value
declines as it ages.

 An asset’s book value could exceed its current value, particularly

if the asset becomes impaired.

 Impairment occurs when events or changed circumstances

reduce the estimated future cash flows of a long-lived asset below its
book value.

 The book value of the asset should then be written down, with
the amount of the write down reported as an impairment loss.
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 Asset Impairment Losses
Assume that one of Cedar Fair’s go-cart ride was
damaged when its book value was $8m and the ride’s
estimated fair value was $4.8m.

The impairment loss would be: $8m – $4.8m = $3.2m

Analyze
Assets = Liabilities + SE
Ride and Equipment -3.2m = Impairment Loss (+E) -3.2m

Record Accounts Debit Credit

Impairment Loss (+E, -SE) 3.2m
Rides and Equipment (-A) 3.2m
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Analyze the disposal
of long-lived assets

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 Disposal of Tangible Assets
 Update depreciation
to the date of disposal.

 Record the disposal by:

Recording cash Recording a

received (debit) gain (credit)
or paid (credit). or loss (debit).

Writing off accumulated Writing off the

depreciation (debit). asset cost (credit).
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 Disposal of Tangible Assets
Cedar Fair sold a hotel for $3,000,000 cash at the
end of its 16th year of use. The hotel originally
cost $20,000,000, and was depreciated using
the straight-line method with zero residual
value and a useful life of 20 years.

Original Cost $20,000,000

Less: Accumulated Depreciation ($1,000,000 x 16 years) -$16,000,000
Book value (BV) at date of sale $4,000,000

Selling Price $3,000,000

Less: Book value -$4,000,000
Loss on Disposal ($1,000,000) 37
 Disposal of Tangible Assets
Analyze
Assets = Liabilities + SE
Buildings -20m = Loss on Disposal (+E) -1m
Accumulated Depreciation (-xA) +16m =
Cash +3m =

Record Accounts Debit Credit

Cash (+A) 3m
Accumulated Depreciation (-xA, +A) 16m
Loss on Disposal (+E, -SE) 1m
Buildings (-A) 20m

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 Analyze the acquisition,
use, and disposal of long-
lived intangible assets

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 Intangible Assets
Intangible assets are long- Trademarks
lived assets that lack
physical substance. Their Copyrights
existence is indicated by
legal documents:
Patents
Licensing Rights
Franchises
Goodwill
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 Acquisition of Intangible Assets
The cost of If an intangible asset is
intangible assets being self-constructed
are recorded as or internally
assets only if they developed, its costs
have been generally are reported
purchased. as research and
development
expenses.
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 Intangible Assets
Goodwill
Occurs when one Only purchased
company buys goodwill is an
another company. intangible asset.

The amount by which the

purchase price exceeds the fair
market value of net assets acquired.
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 Use of Intangible Assets

Limited life Unlimited life

Amortization is the Intangibles with unlimited
process of allocating the useful lives, including
cost of intangible assets trademarks and goodwill,
over their limited useful are not amortized.
lives, using the straight-
line method.

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 Intangible Assets with limited lives
Example
Assume Cedar Fair purchased a patent for an uphill water-
coaster for $800,000 and intends to use it for 20 years.
Each year the company would record $40,000 in Amortization
Expenses ($800,000/20 years).
Analyze
Assets = Liabilities + SE
Patents -40,000 = Amortization Expense (+E) -40,000

Accounts Debit Credit

Record Amortization Expense (+E, -SE) 40,000
Patents (-A) 40,000
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 Cedar Fair’s assets
AT DECEMBER 31
(in millions) 2008 2007
Assets
Current Assets $70 $60
Property and Equipment
Land 320 350
Land Improvement 310 320
Buildings 570 580
Rides and Equipment 1,300 1,270
Construction in Progress 20 30
Property and Equipment, at cost 2,520 2,550
Less: Accumulated Depreciation (720) (610)
Property and Equipment, net 1,800 1,940
Goodwill and Other Intangible Assets 300 390
Other Assets 20 30
Total Assets 2,190 2,420
 Impairment for Intangible Assets
All intangible assets are tested at least annually for possible
impairment, just like long-lived tangible assets.
Cedar Fair’s assets
Current Assets $70
Property and Equipment
Land 320
Land Improvement 310
(in millions) Income Statement 2008
Buildings 570
Net Revenues $1,000
Rides and Equipment 1,300 Operation Expenses:
Construction in Progress 20 Food and Operating Exp. 500
Property and Equipment, at cost 2,520 Depreciation Expense 130
Less: Accumulated Depreciation (720) Selling, General, and Other 130
Property and Equipment, net 1,800 Loss on Disposal of Fixed Assets 10
Goodwill and Other Intangible Assets 300 Impairment Losses 90
Other Assets 20 Total Operating Expenses 860
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Total Assets 2,190 Income from Operations 140
 Disposal of Intangible Assets

Just like Long-lived tangible assets,

disposals of intangible assets result in
gains (or losses) if the amounts received
on disposal are greater than (less than)
their book values.

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 Differences between GAAP and IFRS
GAAP IFRS
Cost versus Fair Value Cost versus Fair Value
• Must record at cost • Choose between either cost or fair
value
• Adjust for depreciation and • Adjust for depreciation and
impairment impairment
• Do not record increases in value • If using fair value, record increases in
value
Research and Development Research and Development
• Expense all costs of researching • Expense research costs but capitalize
and developing intangible assets measurable costs of developing
intangible assets
48
 Interpret the fixed
asset turnover ratio

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 Turnover Analysis
Fixed Asset Turn Over Ratio
This ratio measures the sales dollars generated by each
dollar invested in (tangible) fixed assets. A higher ratio
implies greater efficiency.

Fixed
Net Sales Revenue
Asset =
Turnover Average Net Fixed Assets

Relevant Information 2008 Fixed Asset

(in millions) Turnover Calculation
2008 2007
Cedar Net sales $1,000 $990 $1,000 = 0.53
Fair Net fixed assets 1,800 1,940
($1,800 + $1,940)/2
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 Turnover Analysis
Fixed Asset Turn Over Ratio

Fixed Asset Turnover ratios can vary across

industries because a capital intensity – the need
for tangible assets – varies widely.

2008 Fixed Asset Turnover Comparisons

Yahoo! Six Flags Cedar Fair
5.68 0.64 0.53

51
Describe factors to consider
when comparing companies’
long-lived assets

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 The Impact of Depreciation Differences
• Accelerated depreciation, in the early years of an asset’s
useful life, results in higher depreciation expense, lower net
income, and lower book value than would result using
straight-line depreciation.
• Selling an asset with a low book value, resulting from
accelerated depreciation, might result in a gain. Selling the
same asset with a higher book value, resulting from straight-
line depreciation, might result in a loss.
• The same effects can occur for two companies that use the
same depreciation method but different estimated useful
lives or residual values.

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 Question
Company A uses an accelerated depreciation method while
Company B uses the straight-line method. All other things equal,
during the first few years of the asset's use, Company B will
show which of the following compared to Company A?

A) A smaller fixed asset turnover ratio and a smaller gain on asset

disposal.
B) A larger fixed asset turnover ratio and a larger gain on asset
disposal.
C) A smaller fixed asset turnover ratio and a larger gain on asset
disposal.
D) A larger fixed asset turnover ratio and a smaller gain on asset
disposal.
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 Homework
• Demonstration case: Diversified Industries (p. 425)
– Must read
– Try to answer all questions
– Check your answers with solutions
• Exercises:
- Multiple choice: 1-10 (pp. 430-431)
- E9: 2-6, 12 (pp. 434-437)

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End of Chapter 9

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