Chapter 8: Reporting and Interpreting Property, Plant, Equipment, Intangibles, and Natural Resources

Learning Objectives

  • Define, classify, and explain long-lived productive assets: Understanding the types of assets and their classifications.

  • Apply the cost principle: Measuring acquisition and maintenance costs for property, plant, and equipment.

  • Cost allocation methods: How costs are allocated as assets are used over time.

  • Asset impairment: Effects on financial statements.

  • Analyze disposals: The disposal process for property, plant, and equipment.

  • Measurement and reporting for intangibles: Understanding how to report intangible assets and natural resources.

  • Cash flow impact: How long-lived asset transactions impact cash flows.

Long-Lived Productive Assets

  • Definitions & Classifications:

    • Tangible Assets: Have physical substance. Examples include:

    • Land

    • Buildings

    • Fixtures and equipment

    • Natural resources

    • Intangible Assets: No physical substance. Examples include:

    • Patents

    • Copyrights

    • Trademarks

    • Licenses

    • Goodwill

  • Fixed Asset Turnover Ratio:

    • Formula: Fixed Asset Turnover = Net Sales or (operating revenues) / Average Net Fixed Assets

    • Indicates sales generated per dollar of fixed assets.

Acquisition Costs

  • Components of Acquisition Costs:

    • Purchase price

    • Sales taxes

    • Legal fees

    • Transportation and preparation costs

    • Interest charges are expensed as incurred.

    • Installation and preparation costs

      Note- we say that the expenditures are capitalized when they are recorded as an asset.

  • Example:

    • Acquisition of an aircraft for $26 million includes all relevant costs in the asset’s value.

Cost Allocation Methods

  • Depreciation: Allocation of cost over asset's useful life.

    • Not a measure of market value.

    • Depreciation Methods:

    • Straight-Line: Constant expense each year.

    • Units-of-Production: Cost allocated based on usage.

    • Declining-Balance: Accelerated method; higher expense in early years.

  • Depreciation Calculations: Requires:

    • Estimated useful life

    • Estimated residual value

    • Chosen depreciation method

  • Impact of Different Methods:

    • Different methods can significantly impact reported net incomes. For example, accelerated methods can report lower net income initially.

Repairs, Maintenance, and Improvements

  • Expenditures can be categorized as:

    • Capital Expenditures: Increases value or extends life of the asset.

    • Revenue Expenditures: Routine maintenance costs.


Asset Disposal

  • Disposal Process:

    • Record cash received/payable.

    • Write off asset cost and accumulated depreciation.

    • Record gain or loss on sale.

  • Example of Disposal Calculation:

    • Aircraft sold for $11 million, initially cost $30 million, using straight-line depreciation over 25 years.

    • Net Book Value (17 years later): $30 million - Accumulated Depreciation

    • Gain/loss on sale calculated as difference between cash received and book value.

Intangible Assets

  • Common Types:

    • Goodwill: Recorded only upon acquisition of a company.

    • Trademarks & Copyrights: Rights to brand names and creations.

    • Patents: Exclusive rights for 20 years.

  • Amortization of Intangibles:

    • Definite Life: Amortized over useful life, typically using straight-line method.

    • Indefinite Life: Reviewed annually for impairment, not amortized.

  • Natural Resources

  • Depletion: Allocation process for costs associated with extracting natural resources.

    • Often calculated using units-of-production method.

    • Costs recorded as inventory until sold, when they are then classified as cost of goods sold.

Internal Controls for Long-Lived Assets

  • Essential Controls Include:

    • Asset registration

    • Physical tagging of assets

    • Regular asset audits

    • Policies on capitalization and disposal of assets.

Segregation of Duties: Critical for managing cash and asset sales to reduce risk of loss.

Depreciation Concept

Summary

Understanding these concepts is crucial for proper financial reporting and decision-making in relation to property, plant, equipment, intangibles, and natural resources. Proper tracking, recording, and reporting of these assets impacts a company's financial health and operational efficiency.