Chapter 9 – Long-Lived Tangible & Intangible Assets

Learning Objective 9-1 Long-Lived Assets: Definition & Classification

• Long-lived (non-current) assets ‑ expected to provide economic benefits for ≥1 year; NOT held for resale.
• Two broad categories:
• Tangible assets – have physical substance.
– Land
– Assets subject to depreciation: buildings, equipment, furniture & fixtures.
• Intangible assets – no physical substance; value = legal rights & privileges that generate benefits.
– Limited life (e.g., patents, copyrights) ⇒ subject to amortization.
– Unlimited/indefinite life (e.g., goodwill, trademarks) ⇒ NOT amortized but tested for impairment.

Learning Objective 9-2 Acquisition (Cost Principle) & Capitalization

• Cost principle – record asset at ALL costs necessary & reasonable to acquire and prepare for intended use (capitalize).
• Typical cost components by asset class:
• Land: purchase price, legal/survey/title search fees.
• Buildings: purchase/construction cost, legal, appraisal, architect fees.
• Equipment: purchase/construction cost, sales tax, transportation, installation.
• Basket (lump-sum) purchase – allocate total cost to individual assets proportionally to relative market values.
• IFRS component allocation – extend basket idea to major components; each component depreciated over its own useful life.
• Example – Cedar Fair roller coaster purchase:
– Invoice $26{,}000{,}000$ – $1{,}000{,}000$ discount ⇒ $25{,}000{,}000$ .
– Transportation $125{,}000$ ; installation $625{,}000$ .
– Journal entry:
• Debit Equipment $25{,}750{,}000$
• Credit Notes Payable $25{,}000{,}000$ ; Credit Cash $750{,}000$ .

Subsequent Expenditures While in Use

• Ordinary repairs & maintenance – expense as incurred.
• Extraordinary repairs/additions – capitalize if they extend useful life or increase productivity.

Depreciation Fundamentals (Cost Allocation)

• Depreciation = systematic allocation of the depreciable cost (cost−residual value) over periods benefited, NOT valuation.
• Requires three estimates per asset:

Acquisition (historical) cost.
Estimated useful life.
Estimated residual (salvage) value.
• Accounting effects for yearly depreciation $D$ :
– Debit Depreciation Expense $D$ (Income Statement).
– Credit Accumulated Depreciation (+xA) $D$ (contra-asset on Balance Sheet).

Learning Objective 9-3 Depreciation Methods

1. Straight-Line (SL)

• Formula: $\text{Annual Depreciation}=\dfrac{\text{Cost} - \text{Residual}}{\text{Useful Life}}$ .
• Go-kart example:
$\dfrac{62{,}500-2{,}500}{3}=20{,}000\;\text{per year}$ .

2. Units-of-Production (UOP)

• Step 1 – compute depreciation rate per unit: $\dfrac{\text{Cost}-\text{Residual}}{\text{Total estimated units}}$ .
• Step 2 – yearly depreciation = rate × actual units.
• Year 1 in example (30,000 of 100,000 miles):
$\dfrac{62{,}500-2{,}500}{100{,}000}\times30{,}000 = 18{,}000$ .

3. Declining-Balance (DB) & Double-Declining-Balance (DDB)

• Accelerated; ignores residual in annual computation.
• Generic rate = $\dfrac{1}{\text{Life}}\times\text{Multiplier}$ .
– DDB ⇒ Multiplier = 2.
• Expense = rate × Book Value at beginning of year; limited so BV never < residual.
• Go-kart DDB:
– Yr 1: $(62{,}500-0)\times\dfrac{2}{3}=41{,}667$ .
– Yr 2: $(62{,}500-41{,}667)\times\dfrac{2}{3}=13{,}889$ .
– Yr 3: adjust to reach residual ⇒ $4{,}629$ .

Partial-Year Depreciation

• Prorate annual depreciation by fraction of year asset is owned.

Tax Depreciation

• Separate MACRS/CCA schedules; often more accelerated than GAAP/IFRS reporting.

Learning Objective 9-4 Asset Impairment

• Occurs when carrying amount (book value) > recoverable amount (fair value).
• Two-step accounting:

Remove Accumulated Depreciation against asset.
Write down asset to fair value; recognize Impairment Loss (expense).
• Example – Firehawk coaster:
– Cost $10.6\text{ M}$ ; Acc. Dep. $2.0\text{ M}$ .
– Step 1: Debit Acc. Dep $2.0\text{ M}$ ; Credit Equipment $2.0\text{ M}$ .
– Step 2: Debit Impairment Loss $8.6\text{ M}$ ; Credit Equipment $8.6\text{ M}$ (fair value presumed $0$ ).

Learning Objective 9-5 Disposal of Tangible Assets

• Two steps:

Update depreciation to disposal date.
Record disposal:

Dr  Cash (proceeds)
Dr  Accumulated Depreciation (-xA)
Cr  Asset (cost)
Cr  Gain on Disposal (+R)  OR  Dr  Loss on Disposal (+E)

• Cedar Fair example (junior coaster):
– Cost $100{,}000$ ; 6 years SL, residual $0$ ⇒ Acc. Dep $60{,}000$ ; BV $40{,}000$ .
– Sold for $50{,}000$ ⇒ Gain $10{,}000$ .
– Journal:
• Debit Cash $50{,}000$ ; Debit Acc. Dep $60{,}000$ ; Credit Equipment $100{,}000$ ; Credit Gain $10{,}000$ .

Learning Objective 9-6 Intangible Assets

• Characteristics:
– No physical substance; often provide exclusive legal rights.
– Useful life sometimes ambiguous.
• Initial measurement – record at cash-equivalent cost (purchase price + legal/filing fees).
• Amortization (straight-line):
– Limited-life intangibles: amortize over shorter of economic or legal life.
– Indefinite-life intangibles: NO amortization; test annually for impairment.

Specific Intangibles

• Trademarks – symbols/phrases; internally developed cost not capitalized; purchased trademarks amortized over benefit period.
• Copyrights – legal life = life of creator + 70 yrs; amortize cost if purchased.
• Patents – exclusive right for 20 yrs; cost = purchase + defense; amortize over life or 20 yrs, whichever shorter.
• Licensing rights – limited permission under contract (e.g., campus software).
• Technology assets – software/web; usually 3-7 yr life.
• Franchises – contractual right to sell goods/services; capitalize purchase cost.
• Goodwill – arises only upon acquisition when \text{Purchase Price} > \text{Fair Value of Net Assets}.
– Not amortized; subject to annual impairment testing.
• Amortization example – patent:
– Cost $800{,}000$ ; useful 20 yrs ⇒ $40{,}000$ /yr.
– Debit Amortization Expense; Credit Accumulated Amortization $40{,}000$ .

Learning Objective 9-7 Fixed-Asset Turnover Ratio

• $\text{Fixed Asset Turnover} = \dfrac{\text{Net Revenue}}{\text{Average Net Fixed Assets}}$ .
• Indicates $sales \ dollars \ generated \ per \ dollar \ invested \ in \ fixed assets$ .
• Cedar Fair 2018 example: Revenue $1{,}350$ (millions); Avg Net FA $\frac{1,600+1,590}{2}=1,595$ ⇒
$\dfrac{1,350}{1,595}=0.85$ .

Learning Objective 9-8 Comparability Issues

• Asset method choice affects profit & book value:
– Accelerated depreciation ⇒ higher early-period expense, lower NI & book value.
– Straight-line ⇒ smoother expense; higher BV early on.
• Disposal gains/losses influenced by BV; lower BV from accelerated methods more likely to yield gains on sale.

Supplement 9A Natural Resources (LO 9-S1)

• Depletion – cost allocation for resources (timber, minerals).
• Periodic depletion added to inventory; expensed as COGS when related inventory sold.
• Example: Timber tract $530,000$ ; 20 % cut per year ⇒ annual depletion $530,000\times20\%=106,000$ .
– Debit Timber Inventory $106,000$ ; Credit Accumulated Depletion (+xA) $106,000$ .

Supplement 9B Changes in Depreciation (LO 9-S2)

• Depreciation involves estimates (useful life, residual). If estimates change, prospectively recompute depreciation:
$\text{New Annual Depreciation}=\dfrac{\text{Book Value at change} - \text{New Residual}}{\text{Remaining Life}}$ .
• Example – Equipment cost $60\text{ M}$ ; original 20 yrs, $3\text{ M}$ salvage. After 4 yrs, change to 25 yrs total and $2.4\text{ M}$ salvage. Compute new depreciation for Year 5+ using above formula.

Selected Solved Exercises – Key Mechanics

• M9-4 (SL): Machine $400,000$ ; residual $40,000$ ; life 4 yrs ⇒ $90,000$ /yr; BV end Yr3 $130,000$ .
• M9-5 (UOP): Same cost/residual; 20,000 hrs life. Depreciation each year based on usage (3,000; 8,000; 6,000 hrs). BV end Yr3 $94,000$ .
• M9-6 (DDB): Same asset. Depreciation: Yr1 $200,000$ ; Yr2 $100,000$ ; Yr3 $50,000$ ⇒ BV end Yr3 $50,000$ .
• E9-6–E9-9: Comprehensive schedules demonstrating journal entries and book values under SL, UOP, DDB for equipment costing $22,000$ (residual $2,000$ ) and for Sonic equipment $27,000$ (residual $1,500$ ).
– All schedules illustrate equality of total depreciation $=\text{Cost} - \text{Residual}$ (though timing differs).
• E9-11 (FedEx truck disposal): Shows how different accumulated depreciation balances (\$10k, \$12k, \$15k) with same sale price $16k$ lead to loss $2k$ , no gain/loss, or gain $3k$ respectively; journal entries prepared for each case.

Ethical, Practical & Reporting Implications

• Capitalization vs expensing choices shift profit between periods.
• Accelerated vs straight-line affects taxes & external perception of ROA.
• Impairment & goodwill write-downs may signal future cash-flow issues.
• Fixed-asset turnover aids in comparing operating efficiency but must be interpreted alongside depreciation policy choices.

Formulas Recap (in LaTeX)

• Straight-Line: $\text{Depreciation}=\dfrac{\text{Cost}-\text{Residual}}{\text{Useful\;Life}}$
• Units-of-Production: $\text{Depreciation}=\dfrac{\text{Cost}-\text{Residual}}{\text{Total\;Units}}\times\text{Units this period}$
• Declining-Balance: $\text{Rate}=\dfrac{m}{\text{Useful Life}};\;\text{Depreciation}=\text{Rate}\times\text{Book Value}_{\text{BOY}}$ (where $m=2$ for DDB).
• Fixed-Asset Turnover: $\dfrac{\text{Net Revenue}}{\text{Average Net Fixed Assets}}$ .
• Depletion (percentage method): $\text{Depletion}=\text{Cost}\times\text{Depletion Rate}$ .