Non-Current Assets Plant Assets and Intangible Assets Chapter

Non-Current Assets: Plant Assets and Intangible Assets Chapter 10 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

Objectives 1. Measure the cost of a non-current asset. 2. Account for depreciation 3. Select the best depreciation method for income tax purposes 4. Account for the disposal of a non-current asset 5. Account for the revaluation of a noncurrent asset 6. Account for intangible assets and amortisation Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 2

Non-current Assets Asset Account Related Expense Account Plant Assets Land…………………… Buildings, Machinery and Equipment, Furniture and Fixtures, and Land Improvements……………… Natural Resources……………. . Intangibles…………………. . None Depreciation Depletion Amortisation Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 3

Objective 1 Measure the cost of a non-current asset. Horngren ♦ Harrison ♦ Bamber

Cost Principle An asset must be carried on the statement of financial position at the amount paid for it. The cost of an asset equals the sum of all of the costs incurred to bring the asset to its intended purpose. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 5

Land Improvements Purchase price of land Add related costs: Back property taxes Stamp duty Removal of buildings Survey fees Total cost of land $ 500, 000 $ 40, 000 8, 000 5, 000 1, 000 54, 000 $ 554, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 6

Land Improvements l All improvements located on the land but subject to decay: Paving Fences Sprinkler systems Lights in parking lot Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 7

Buildings – Construction Architectural fees Building permits Contractor’s charges Interest during construction Materials Labour Overhead Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 8

Buildings – Purchasing Purchase price Agents commissions Stamp duty Repairing or renovating building for its intended purpose Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 9

Machinery and Equipment Purchase price (less trade discounts) Transportation charges Insurance in transit Customs duties Installation cost Expenditures to test asset before it is placed in service Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 10

Finance Leases What are finance leases? l They are lease arrangements similar to instalment purchases. l Finance leases are reported as assets, even though the company does not own the asset. l Leasehold improvements are similar to land improvements. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 11

Capitalising the Cost of Interest Suppose on January 2, 2004, Coats Hire borrows $1, 000 on a two-year, 10% loan, to build a warehouse. l Total interest for the financial year ended 30/6/04 is 6/12 x $100, 000 = $50, 000. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 12

Capitalising the Cost of Interest June 30, 2004 Building 50, 000 Interest Payable (or cash) 50, 000 Accrued interest of construction loan Note Interest Expense was not debited. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 13

Lump-Sum Purchases Example Andrea Lim paid $110, 000 for a combined purchase of land a building. l The land is appraised at $90, 000 and the building at $60, 000. l How much of the purchase price is allocated to land how much to the building? l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 14

Lump-Sum Purchases Example Land: $90, 000 ÷ $150, 000 = 60% $110, 000 × 60% = $66, 000 Building: $60, 000 ÷ $150, 000 = 40% $110, 000 × 40% = $44, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 15

Distinction Between Capital Expenditures and Expenses Does the expenditure increase capacity or efficiency or extend useful life? YES NO Capital Expenditure Debit Non-current Assets accounts Expense Debit Repairs and Maintenance account Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 16

Measuring the Depreciation of Property, Plant & Equipment Cost Estimated useful life Estimated residual value Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 17

Objective 2 Account for depreciation. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser

Depreciation Methods Straight-Line (SL) Units-of-Production (UOP) Reducing-Balance (RB) Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 19

Depreciation Methods Example Donishia and Richard Catering, purchased a delivery van on July 1, 2004, for $22, 000. l They expect the van to have a trade-in value of $2, 000 at the end of its useful life. l The van has an estimated service life of 100, 000 km or 4 years. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 20

Straight-Line Method Example (Cost – Residual value) ÷ years of useful life ($22, 000 – 2, 000) ÷ 4 = $20, 000 ÷ 4 = $5, 000 Year 1 Depreciation: Year 2 Depreciation: Year 3 Depreciation: Year 4 Depreciation: Total Depreciation: $ 5, 000 $20, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 21

Units-of-Production Method Example ($22, 000 – 2, 000) ÷ 100, 000 km = $. 20/km Year 1: 30, 000 miles = $ 6, 000 Year 2: 27, 000 miles = 5, 400 Year 3: 23, 000 miles = 4, 600 Year 4: 20, 000 miles = 4, 000 Total: 100, 000 miles = $20, 000 (Actual mileage in year 4 was 22, 000) Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 22

Reducing-Balance Method Example Straight-line rate is 100% ÷ 4 = 25% l Reducing-balance is approximately 1. 5 times the straight-line rate = 37. 5% l What is the book value of the van at the end of the first year? l $ 22, 000 × 37. 5% = $ 8, 250 l $ 22, 000 – $ 8, 250 = $ 13, 750 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 23

Reducing-Balance Method Example June 30, 2005 Depreciation Expense $ 8, 250 Accumulated Depreciation $ 8, 250 To record depreciation expense for a one-year period Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 24

Reducing-Balance Method Example Remember the book value of the van at the end of the first year? l $ 22, 000 – $ 8, 250 = $ 13, 750 l Depreciation for the second year is l $ 13, 750 × 37. 5% = $ 5, 156 l Giving a book value of l $ 13, 750 - $ 5, 156 = $ 8, 594 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 25

Comparing Depreciation Methods Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett,

Comparing Depreciation Methods The $ 1, 357 difference in reducing balance is due to the inaccuracy of using 1. 5 times the straight line method. l Using the formula on page 416 of the textbook the rate is. 451% l This gives depreciations of l $9, 922 + $5, 447 + $2, 990 + $1, 641 = l $20, 000 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 27

Objective 3 Select the best depreciation method for income tax purposes. Horngren ♦ Harrison

Relationship Between Depreciation and Taxes Most businesses use straight line depreciation for financial reporting. l For tax purposes businesses can use; ä ‘Prime Cost’ which is straight line. ä ‘Diminishing Value’ which is reducing balance at 1. 5 times the straight line rate. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 29

Depreciation for Partial Years Assume that Donishia and Richard Catering, owned the van for 3 months. l How much is the van’s depreciation? l Prime cost method: $5, 000 × 3/12 = $1, 250 Reducing-balance method: $8, 250 × 3/12 = $2, 062 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 30

Revising Depreciation Rates Revised SL depreciation = Cost – Accumulated depreciation – New residual value ÷ Remaining useful life Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 31

Objective 4 Account for the disposal of a non-current asset. Horngren ♦ Harrison ♦

Disposing of Non-current Assets selling – exchanging – discarding (scrapping it) l Gain/loss is reported on the Statement of Financial Performance. . . – and closed to Profit and Loss Summary. – Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 33

Disposing by Discarding Example Ly the manager of Ly’s Landscaping, is contemplating the disposal of an old piece of equipment: l Equipment cost: $ 36, 000 l Residual value: $ 6, 000 l Accumulated depreciation 30/6/05: $ 20, 000 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 34

Disposing by Discarding Example Assume the equipment is discarded on 30/9/05. l What is the accumulated depreciation on September 30? l ($36, 000 – $6, 000) ÷ 10 = $3, 000 ÷ 12 = $250 × 3 = $750 $20, 000 + $750 = $20, 750 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 35

Disposing by Discarding Example September 30, 2005 Accumulated Depreciation Carrying amount of asset Equipment 20, 750 15, 250 36, 000 To record discarding of equipment Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 36

Selling a Non-current Asset Example Assume the equipment is sold for $10, 000. l September 30, 2005 Cash 10, 000 Proceeds of Sale N-C Asset 10, 000 l Accumulated Depreciation Carrying amount of N-C Asset Equipment 20, 750 15, 250 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 37

Selling a Non-current Asset Example l AASB 1018 Statement of Financial Performance requires; ä The removal in the asset account and the related accumulated depreciation ä Proceeds from the sale be included in total revenue ä And the carrying amount of the assets sold be included in total revenue. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 38

Exchanging Non-current Assets Assume the same equipment (with a cost of $36, 000 and a book value of $15, 250) is exchanged for new, similar equipment having a cost of $42, 000 a trade-in of $18, 000 is allowed. l Cash payment is $24, 000. l The trade in value is the proceeds from sale l The carrying value the expense l The cost of the new equipment $42, 000 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 39

Internal Control of Non-current Assets Cornerstone of internal control is separating custody of assets from accounting for the asset l Also need physical controls – to prevent theft, maintain physical condition. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 40

Objective 5 Account for the revaluation of a non-current asset Horngren ♦ Harrison ♦

Revaluation AASB 1041 Revaluation of Non-current Assets allows assets to be recorded at cost or ‘fair value’ l Upward revaluations are credited to owners equity (Asset Revaluation Reserve account) l Downward revaluations are debited to an expense. l For depreciable assets the accumulated depreciation is credited against the asset. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 42

Objective 6 Account for intangible assets and amortisation. Horngren ♦ Harrison ♦ Bamber ♦

Intangible Assets Not physical in nature Patents Copyrights Trademarks Franchises Goodwill Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 44

Intangible Assets: Patents are government grants. l They give the holder the right to produce and sell an invention for 20 years. l Suppose a company pays $170, 000 to acquire a patent on July 1. l The company believes that its expected useful life is 5 years. l What are the entries? l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 45

Intangible Assets: Patents July 1 (this year) Patents Cash 170, 000 To acquire a patent June 30 (next year) Amortisation Expense Patents 34, 000 To amortise the cost of a patent Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 46

Intangible Assets: Copyrights Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 47

Intangible Assets: Trademarks, Trade Names, or Brand Names are assets that represent distinctive identifications of a product or service. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 48

Intangible Assets: Franchises l Franchises are privileges granted by private business or government to sell a product or service. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 49

Intangible Assets: Goodwill Example Purchase price paid for Mexana Company Assets at market value Less Mexana’s liabilities Market value of Mexana’s net assets Goodwill $10 million 9 million 1 million 8 million $ 2 million Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 50

Special Issues International accounting for goodwill Research and development Ethical Issue: Capitalise or expense expenditure Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 10 - 51