In Class Live Session #8

Prepared by Dr. Sudhakar Balachandran

Agenda

1. Recap, Key Parts of Accounting for PP&E

2. Practice Problem 8-8
3. Continue Review of Tata Steel Financials (Time
Permitting, or in Session 9)
1. Inventory
2. Accounts Receivable
3. PP&E

2
 Things You Need to Know:

1. Introduce T Account Structure Used in Long

Lived Assets
2. PPE
A. Determining historical value
B. Depreciation measurement
3. Accounting for Intangibles
A. Internally Generated Intangibles
B. Acquired Intangibles
4. Disposal of Long Term Assets
5. Analysis of Long Term Assets
6. Cash Flow Implications of Long Term Assets

3
 T-Account Structure of Long Lived Assets

Long Lived Asset Contra Asset D/A Expense

BB BB
Depreciation
Decreases Increases
Increases Decreases Or

Amortization
EB EB

Similar to What you Saw With Accounts Rec

• Historical values captured in first T account
• Changes over time captured separately
• Connected to Income Statement

4
 Case 1: Tangible Long Lived Assets

Accumulated Depreciation
Prop. Plant & Eq. Depreciation Expense

BB BB
Depreciation
Decreases Increases
Increases Decreases

EB EB

For Tangible Assets

• Prop Plant and Equip
• Contra Account is Accumulated Depreciation
• Income Statement Carries Depreciation Expense

5
 Case 2: Intangible Long Lived Assets

Accumulated Amortization
Intangibles Amortization Expense

BB BB
Depreciation
Decreases Increases
Increases Decreases

EB EB

For Intangible Assets

• The term Amortization is Used
• Some Assets May Not Be Amortized

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 Nike, Inc.
Property, Plant, and
Equipment (in millions)
Land $ 222.8
Buildings 951.9
Machinery and equipment At 2,217.5
Leasehold improvements Cost 820.6
Construction in progress 177.0
$ 4,389.8
Less accumulated depreciation (2,457.9)
Property, plant, and equipment (net) $ 1,931.9

Book Value
LO 1
 Acquisition Cost of PP&E
All costs necessary to acquire asset and
prepare for intended use
Examples:
Purchase price
Purchase
Taxes paid at time of purchase
Price
+ Transportation charges
Taxes
Installation Costs

LO 2
 Group Asset Purchases
Allocate cost of lump-sum purchase based on fair market values

% of Allocated
Fair Market Cost Cost
Value Market
Value
Building = 75% X $100,000 = $75,000
$90,000
Land =
$30,000 25% X $100,000 = $25,000
LO 3
 Capitalization of Interest
Interest can be included as part of the cost of
an asset if:
• company constructs asset over time, and
• borrows money to finance construction

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 Land Improvements
Land improvements with a limited life should
be kept separate from the land since:
• Land improvements that have a limited life would
be subject to depreciation over the useful life of the
improvement
• Land has an unlimited life and therefore is not
subject to depreciation

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 Depreciation of PP&E
Match With
costs of periods
assets benefited

via
Straight-Line Units of Accelerated
Production Methods

LO 5
 Straight-Line Method
 Allocates cost of asset evenly over its useful life

$9,000
3-year life

$3,000 $3,000 $3,000

Year 1 Year 2 Year 3
Units-of-Production Method
Allocate asset cost based on number of units
produced over its useful life

Depreciation =
$ per unit
 Double-Declining-Balance
Method
Double the straight-line rate on a declining balance (book
value)
Accelerated method - higher amount of depreciation in
early years

Straight-line
Rate
 Depreciation Example
On January 1, 2012, ExerCo purchases
a machine for $20,000. The life of the
machine is estimated at five years, after
which it is expected to be sold for $2,000.
 Depreciation Example
Calculate ExerCo’s depreciation of the
machine for 2012–2016 using the
units-of-production and double-declining-
balance depreciation methods.
$20,000 cost – $2,000 residual value =
$18,000 to be depreciated
 Straight-Line Depreciation
Depreciation = Cost – Residual Value
Life

= $20,000 – $2,000
$18,000 5 years
5-year life
= $3,600/year

$3,600 $3,600 $3,600 $3,600 $3,600

2012 2013 2014 2015 2016
 Units-of-Production
Depreciation
ExerCo’s estimated machine production:

2012 3,600 units

2013 3,600 units
2014 3,600 units
2015 3,600 units
2016 3,600 units
Total 18,000 units
 Units-of-Production
Depreciation
Depreciation = Cost - Residual Value
per unit Life in Units

= $20,000 – $2,000
18,000

= $ 1.00 per unit

 Units-of-Production
Depreciation
 ExerCo’s depreciation in 2012:

4,000 units x $1/unit = $ 4,000

 Double-Declining-Balance
Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 5 years) x 2
= 40%
Initially
ignore
residual value
 Double-Declining-Balance
Depreciation
2012 Depreciation = Beginning book value x rate
= $20,000 x 40%
= $8,000

Beginning Ending
Year Rate Book Value Depreciation Book Value
2012 40% $20,000 $8,000 $12,000
 Double-Declining-Balance
Depreciation
2012 Depreciation = Beginning Book Value × Rate
= $12,000 × 40%
= $4,800

Beginning Ending
Year Rate Book Value Depreciation Book Value
2012 40% $20,000 $8,000 $12,000
2013 40% $12,000 $4,800 $7,200
Double Declining-Balance
Depreciation
Beginning Ending
Year Rate Book Value Depreciation Book Value
2012 40% $20,000 $8,000 $12,000
2013 40% 12,000 4,800 7,200
2014 40% 7,200 2,880 4,320
2015 40% 4,320 1,728 2,592
2016 40% 2,592 592 2,000
$18,000
Final year’s depreciation =
amount needed to equate book = Residual
value with salvage value Value
Straight-line vs. DDB Depreciation

2012 2013 2014 2015 2016

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 Changes in Depreciation
Estimates
Recompute depreciation schedule
using new estimates
Record prospectively (i.e., change
should affect current and future
years only)

LO 6
 Change in Estimate
Example:

$20,000 machine originally expected to be depreciated over

5 years. After 2 years, useful life is increased to 7 years.

planned
$3,600 $3,600 $3,600

2012 2013 2014 2015 2016

Depreciation revise
estimate
 Change in Estimate
Example:

$10,800 ($12,800 remaining book value – $2,000

salvage) allocated over remaining life
$3,600 $3,600 $2,160 $2,160 $2,160 $2,160 $2,160

2012 2013 2014 2015 2016 2017 2018

revise
estimate Depreciation
 Capital vs. Revenue
Expenditures
Capital Expenditure
• Treat as asset addition to Balance
Sheet
be depreciated over a
period of time

Revenue Expenditure
Income
• Expense immediately Statement

LO 7
 Capital vs. Revenue
Expenditures
Category Example Asset or Expense
Normal maintenance Repainting Expense
Minor repair Replace spark plugs Expense
Major repair Replace a vehicle’s
engine Asset*
Addition Add a wing to a
building Asset

*if life or productivity is enhanced

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 Capital Expenditures
Example:
A $20,000 machine purchased on January 1, 2012 is originally
expected to be depreciated over 5 years. After 2 years, an
overhaul of the machine is made at a cost of $3,000. Machine
life is increased by 3 years.
planned
$3,600 $3,600 $3,600

2012 2013 2014 2015 2016

replace
engine
 Capital Expenditures
Example:

$12,800 remaining book value + $3,000 capital

expenditure depreciated prospectively over
remaining life, (note life increases by 3 years so
through 2019, salvage value still 2000)
$3,600 $3,600 $2,300 $2,300 $2,300 $2,300 $2,300

2012 2013 2014 2015 2016 2017 2018

replace $2,300
engine 2019
Disposal of Operating Assets

 Record depreciation up to date of disposal

 Compute gain or loss on disposal

Proceeds > Book Value = Gain

Proceeds < Book Value = Loss

LO 8
Disposal of Operating Assets
Example:
Sell truck (cost $20,000; accumulated depreciation
$9,000) for $12,400

Sale price $ 12,400

Less book value:
Asset cost $20,000
Less: accumulated
depreciation 9,000 ( 11,000)
Gain on sale $ 1,400
Disposal of Operating Assets
Example:
Sell truck (cost $20,000; accumulated depreciation
$9,000) for $10,000

Sale price $ 10,000

Less book value:
Asset cost $20,000
Less: accumulated
depreciation 9,000 ( 11,000)
Loss on sale $ 1,000
 Gain/Loss on Sale of
Operating Asset
Gain or Loss on Sale of Operating Asset
appears on the Income Statement
 Gain or Loss on Sale of Operating Asset is
reported as Other Income/Expense since
it does not constitute the company’s
ongoing or central activity
Discussion Problem 8-8

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 Depreciation for 2011
Accumulated Depreciation
Building Depreciation Expense

364,000 14,000 14,000

39
 In 2102, Painting Is a Revenue Expenditure
Accumulated Depreciation
Building Depreciation Expense
364,000 14,000 14,000

40
 But Pollution Control is a Capital Expenditure
Accumulated Depreciation
Building Depreciation Expense
364,000
14,000 14,000
42,000

41
 But Pollution Control is a Capital Expenditure
Accumulated Depreciation
Building Depreciation Expense
364,000
14,000
42,000 12,600 12,600

42
 The Building Is Sold On April 1, 2013
Accumulated Depreciation
Building Depreciation Expense
364,000
14,000
42,000 12,600 3,150
3,150

Debit Credit
Deprec. Exp. 12,600/4

Acc. Depr. (A.D.) 3,150

Because 3 months (1/4 of a year) of depreciation needs to be

recorded prior to Sale
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 Asset Disposal: What Happens When
Building is Sold?
Cash Building A. D Gain/Loss
392,000 364,000
14,000
42,000
12,600
3,150
406,000 29,750 15, 750

Debit Credit
Cash 392,000
A.D. 29,750
Building 406,000
Gain on Disposal 15,750

Note: Gain is a Plug Number that Makes The Debits and Credits
Balance. But it is also an estimate of how much you made on the
disposal 44
 What if Life of Bldg. Had NOT Been
Extended?
Cash Building A. D Gain/Loss
392,000 364,000
14,000
364,000 59,000
14,000
3,500
31,500

Debit Credit
Cash 392,000
A.D. 31,500
Building 364,000
Gain on Disposal 59,500

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If We Expensed The Pollution Control Device

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Things You Should Know About Long Lived
Assets

1. T Account Structure
2. How to Record Spending Cash to Create Long
Lived Assets
3. How to Record Depreciation or Amortization
4. How to Differentiate Revenue Expenditures vs.
Capital Expenditures
5. How to Handle Changes to Depreciable Life
6. How to Calculate and Record Gains/Losses on
Disposal

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Side Note: Sad Demise of My Investment in
Petrol Refinery

Costs To Build Refinery:

Purchase price
Taxes paid at time of purchase
Transportation charges
Importation Duties and Taxes
Interest Expenses

Unfortunately, We “Just Wrote It Off”

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