chapter 8 Reporting and Interpreting

Property, Plant, and Equipment;

Intangibles; and Natural
Resources

Financial Accounting
11e
Libby • Libby • Hodge

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Learning Objectives
After studying this chapter, you should be able to:

8-1 Define, classify, and explain the nature of long-lived productive

assets and interpret the fixed asset turnover ratio.
8-2 Apply the cost principle to measure the acquisition and
maintenance of property, plant, and equipment.
8-3 Apply various cost allocation methods as assets are held and used
over time.
8-5 Analyze the disposal of property, plant, and equipment.
8-6 Apply measurement and reporting concepts for intangible assets
and natural resources.

More ratio: Return on assets ratio (p.697 and 699)

Chapter Supplement: Changes in Depreciation Estimates (p.435)

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Learning Objective 8-1
8-1 Define, classify, and explain the nature of long-lived productive
assets and interpret the fixed asset turnover ratio.

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Classifying Long-Lived Assets

Tangible Intangible
Physical No Physical
Substance Substance

 Patents
 Land  Copyrights
 Buildings, fixtures, and equipment  Franchises
 Natural resources  Licenses
 Trademarks
 Goodwill

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Exhibit 8.1 FedEx Corporation’s Asset Section of the
Balance Sheet

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Fixed Asset Turnover (Added from Chapter 13)

Fixed Asset = Net Sales (or Operating Revenues)

Turnover Average Net Fixed Assets

This ratio measures the sales dollars generated by each dollar of fixed
assets used. A high rate suggests effective management.

The FedEx ratio for fiscal year ended May 31, 2020 is (in millions):

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Exhibit 13.2 (1 of 3)
Component Percentages for The Home Depot

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Exhibit 13.1 The Home Depot Financial Statements (1 of 2)
(2 of 3)

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Exhibit 13.1 The Home Depot Financial Statements (2 of 2)
(3 of 3)

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Return on Assets (ROA)

This ratio compares income to the total assets used to generate the income .

On average, for every $1.00 of assets reported on The Home Depot’s

balance sheet, the company earned just over 21 cents in fiscal 2020.

Comparison with Lowes: The ROA for Lowe’s was 13.54 percent,
considerably lower than the ROA for The Home Depot. This comparison
indicates that The Home Depot is utilizing its assets to generate income
more effectively than Lowe’s.

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Learning Objective 8-2
8-2 Apply the cost principle to measure the acquisition and
maintenance of property, plant, and equipment.

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Measuring and Recording Acquisition Cost (1 of 3)

All reasonable and necessary expenditures made in acquiring and

preparing an asset for use (or sale, as in the case of inventory) should be
recorded as the cost of the asset. Interest charges associated with the
purchase are recorded as expenses as incurred.

Acquisition Costs
• Purchase price
• Sales taxes
• Legal fees
• Transportation costs
• Installation and preparation costs

Note - We say that the expenditures are capitalized

when they are recorded as an asset.

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Measuring and Recording Acquisition Cost (1 of 3)

Acquisition for Cash - FedEx paid cash to purchase an aircraft for $26 million,
including related transportation and preparation costs.

Debit Credit
Aircraft (+A) 26
Cash (-A) 26

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Measuring and Recording Acquisition Cost (2 of 3)
Acquisition for Debt - FedEx signed a note payable for the new aircraft and
paid cash for the transportation and preparation costs.

Debit Credit
Aircraft (+A) 26
Cash (-A) 1
Note Payable (+L) 25

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Measuring and Recording Acquisition Cost (3 of 3)
Acquisition for Equity - FedEx gave ATR 1,000,000 shares of new $1.00 par
value common stock with a market value of $10 per share and paid the
balance of the plane plus transportation and preparation costs in cash.

Debit Credit
Aircraft (+A) 26
Common Stock (+SE) 1 1
Additional paid-in capital (+SE) 2 9
Cash (−A) 16

1 1,000,000 shares × $1 par

2 1,000,000 shares × $9 excess

($10 market value − $1 par)

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Measuring and Recording Acquisition Cost
Acquisition by Construction (1 of 2)

Asset cost includes:

A reasonable
All materials and amount of Interest on debt
labor traceable to overhead. incurred during
the construction. the construction.

Building

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Measuring and Recording Acquisition Cost
Acquisition by Construction (2 of 2)
Assume FedEx constructed a new hangar, paying $8 million in labor costs and
$11 million in supplies and materials. FedEx also paid $1 million in interest
expense during the year related to the construction project.

The following journal entry is made to record the asset:

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Repairs, Maintenance, and Improvements (1 of 3)

Type of Accounting
Expenditure Identifying Characteristics Treatment
1. Maintains the productive capacity of the asset
Ordinary during the current acounting period only Expense
repairs and 2. Recurring in nature in the
maintenance 3. Involve small amounts period
4. Do not increase the productive life, operating incurred
efficiency, or capacity of the asset

1. Increase the productive life, operating efficiency,

Improvements or capacity of the asset Add to
2. Occur infrequently asset
3. Involve large amounts of money account
(Capitalize)

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Repairs, Maintenance, and Improvements (2 of 3)

To avoid spending too much time classifying additions and improvements

and repair expenses, some companies record all expenditures below a
certain dollar amount as expenses.

Such policies are acceptable because immaterial amounts will not affect
users’ decisions when analyzing financial statements.

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Repairs, Maintenance, and Improvements (3 of 3)
FedEx reported $2,893 million in Maintenance and Repairs on its income
statement.

FedEx spent $300 million in 2023 to modify the cargo area of its oldest
aircraft to reduce weight, resulting in 9 percent greater fuel efficiency and
lower operating costs. These expenditures would have been recorded by
FedEx, as capital expenditures:

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Learning Objective 8-3
8-3 Apply various cost allocation methods as assets are held and used
over time.

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Depreciation Concepts (1 of 2)

Depreciation is the process of allocating the cost

of buildings and equipment over their productive lives
using a systematic and rational method.

Balance Sheet Income Statement

Cost Allocation
Acquisition Cost Expense

(Unused) (Used)

Depreciation Depreciation Income

Expense (current year) Statement

Accumulated Total depreciation Balance

Depreciation (to date) Sheet

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Depreciation Concepts (2 of 2)
 Depreciation is the process of
allocating the cost of
buildings and equipment over
their productive lives using a
systematic and rational
method.

 Depreciation is not a process

of determining an asset’s
current market value or
worth. The remaining balance
sheet amount probably does
not represent the asset’s
current market value.

Depreciation has nothing to do with an asset’s market value (as if you

were going to sell it) because your intent is to use it.

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Adjusting for Depreciation (1 of 3)
An adjusting journal entry is needed at the end of each
period to reflect the use of buildings and equipment for
the period.

Debit Credit
Depreciation expense (+E, -SE) x,xxx
Accumulated depreciation (+XA, -A) x,xxx

Cost XX
− Accumulated Depreciation − XX
Net Book Value XX

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Adjusting for Depreciation (2 of 3)
• The amount of depreciation recorded during each period is reported on
the income statement as Depreciation Expense.
• The amount of depreciation expense accumulated since the acquisition
date is reported on the balance sheet as a contra-account, Accumulated
Depreciation, and deducted from the related asset’s cost.
• The net amount on the balance sheet is called net book value or
carrying value.

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Adjusting for Depreciation (3 of 3)

To calculate depreciation expense, three pieces of information

are required for each asset:
1. Estimated useful life
2. Estimated residual (or salvage) value at the end of the
assets’ useful life
3. Depreciation method

Depreciation methods:
 Straight-line
 Units-of-production
 Declining-balance

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Book Value as an Approximation of Remaining Life

Some analysts compare the book value of assets to their original cost as an
approximation of their remaining life.
Example:
 If book value of an asset is 100 percent of its cost, it is a new asset.
 If book value of an asset is 25 percent of its cost, it only has around 25
percent of its life remaining.

This comparison suggests that the

flight equipment of FedEx and UPS
may be slightly older than the
equipment at DHL.

This comparison is only a rough

approximation and is influenced
by how fast a company
depreciates its assets.

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Exhibit 8.2 Data for Illustrating the Computation of
Depreciation under Alternative Methods

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Straight-Line Method (1 of 2)

Notice that:
 Depreciation expense is a constant amount each year.
 Accumulated depreciation increases by an equal amount each year.
 Net book value decreases by the same amount each year until it
equals the estimated residual value.

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Straight-Line Method (2 of 2)

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Units-of-Production Method (1 of 2)

Divide the depreciable cost (cost minus residual value) by the estimated total
production or activity level to determine the depreciation unit rate as follows:

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Units-of-Production Method (2 of 2)

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Declining-Balance Method
- An Accelerated Depreciation Method

If an asset is more efficient or productive when it is newer,

managers might choose the declining-balance depreciation
method to match a higher depreciation expense with higher
revenues in the early years of an asset’s life and a lower
depreciation expense with lower revenues in the later years.

This is an accelerated depreciation method.

Accelerated methods are seldom used for financial reporting
purposes.

Depreciation Expense Revenues

Early Years High High
Later Years Low Low

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Double Declining-Balance Method (1 of 3)

At the beginning of the year, FedEx purchased equipment for

$62,500 cash. The equipment has an estimated useful life of three
years and an estimated residual value of $2,500.

Annual computation ignores residual value.

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Double Declining-Balance Method (2 of 3)

Two important differences between this method and the other

depreciation methods:
1. Accumulated depreciation, not residual value, is included in the
formula.
• Because accumulated depreciation increases each year, net
book value (Cost minus Accumulated Depreciation) decreases.
• The double-declining rate is applied to a lower net book value
each year, resulting in a decline in depreciation expense over
time.
2. As with the other methods, the net book value should not be
depreciated below the residual value.
• If the computation reduces net book value below residual value,
only the amount of depreciation expense needed to make net
book value equal to residual value is recorded, and no additional
depreciation expense is computed in subsequent years.
• In the last year of the asset’s estimated useful life, whatever
amount is needed to bring net book value to residual value is
recorded, regardless of the amount of the depreciation
computation.
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Double Declining-Balance Method (3 of 3)

Depreciation expense is limited to the

amount that
reduces book value to the estimated
residual value.

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Summary of the Three Depreciation Methods

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Impact of Alternative Depreciation Methods

Accelerated depreciation methods report higher depreciation and,

therefore, lower net income during the early years of an asset’s life. As
the age of the asset increases, this effect reverses.

The graph shown illustrates the

relationship between the double-
declining-balance method and the
straight-line method of depreciation.

Differences in depreciation methods

rather than real economic
differences can cause significant
variation in reported net incomes.

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Learning Objective 8-5
8-5 Analyze the disposal of property, plant, and equipment.

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Disposal of Property, Plant, and Equipment (1 of 5)
Businesses dispose of assets involuntarily (the result of a casualty such as a
storm, fire, theft, or accident) or voluntarily (sales, trade-ins, and retirements).

 Update depreciation expense through the date of disposal

 Record disposal by:

• Recording cash received (debit) or paid (credit)

• Writing off the asset cost (credit) and any accumulated
depreciation (debit).
• Recording a gain (credit) or loss (debit).

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Disposal of Property, Plant, and Equipment (2 of 5)

FedEx sold an aircraft for $11 million cash at the end of its 17th
year of use. The aircraft originally cost $30 million and was
depreciated using the straight-line method with zero residual
value and a useful life of 25 years.

The amount of depreciation expense recorded at the end of the 17th

year to bring depreciation up to date is:

Annual Depreciation:
a. $0 ($30,000,000 – $0) ÷ 25 years
b. $1.2 million = $1,200,000
c. $1.5 million
d. $2 million

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Disposal of Property, Plant, and Equipment (3 of 5)

FedEx sold an aircraft for $11 million cash at the end of its 17th
year of use. The aircraft originally cost $30 million and was
depreciated using the straight-line method with zero residual
value and a useful life of 25 years.

After updating the depreciation, the equipment’s book value at the end
of the 17th year is:
Accumulated Depreciation =
a. $9.6 million
(17yrs. × $1,200,000) = $20,400,000
b. $20.4 million
c. $12.8 million BV = Cost – Accumulated Depreciation
d. $6.6 million BV = $30,000,000 – $20,400,000
= $9,600,000

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Disposal of Property, Plant, and Equipment (4 of 5)

FedEx sold an aircraft for $11 million cash at the end of its 17th
year of use. The aircraft originally cost $30 million and was
depreciated using the straight-line method with zero residual
value and a useful life of 25 years.

The equipment’s sale resulted in:

a. a gain of $1.4 million Gain = Cash Received – Book Value

b. a loss of $1.7 million Gain = $11,000,000 – $9,600,000 =
c. a gain of $3.8 million $1,400,000
d. a gain of $6.2 million

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Disposal of Property, Plant, and Equipment (5 of 5)
Prepare the journal entry to record depreciation expense for Year 17:

Prepare the journal entry to record Southwest’s sale of the aircraft

at the end of the 17th year.

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Learning Objective 8-6
8-6 Apply measurement and reporting concepts for intangible assets
and natural resources.

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Nature of Intangible Assets
 Intangible assets are increasingly important resources for organizations.
 An intangible asset has value because of certain rights and privileges
often conferred by law on its owner.
 An intangible asset has no material or physical substance. Instead, most
intangible assets usually are evidenced by a legal document.

Most common types of intangible assets:

• Goodwill (recognized in a business merger or acquisition)
• Trademarks
• Copyrights
• Technology (computer software and website)
• Patents
• Franchises
• Licenses and operating rights
• Other (customer lists/relationships, noncompete covenants, contracts
and agreements)

Intangible assets are recorded at historical cost only if they have been
purchased. If these assets are developed internally by the company, they are
expensed when incurred.
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Amortization of Intangible Assets
Upon acquisition of intangible assets, managers determine whether
they have definite or indefinite lives:

Definite Life Indefinite Life

• Cost is allocated (amortized) • Not amortized.
over its useful life.
• Asset must be reviewed at
• Straight-line method used to least annually for possible
calculate amortization impairment of value (first
expense (recorded on the using qualitative factors).
income statement).
• If impaired, the carrying
• Most companies do not value is reduced to fair
estimate a residual value. market value.

Amortization is a cost allocation process similar to

depreciation and depletion.
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Common Intangibles (1 of 4)
Goodwill:
• Goodwill is only recorded as an asset when one company buys
another business.
• Internally developed goodwill (such as a favorable reputation)
is not reported as an asset.
• The amount of goodwill equals the purchase price of the company
less the fair market value of the net assets (assets minus liabilities).
• Goodwill is not amortized but is reviewed annually for impairment.

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Common Intangibles (2 of 4)
Trademarks :
• A special name, image or slogan identified with a product or
company.
• Rarely seen on balance sheets because they are only recorded if
purchased.

Copyrights:
• The exclusive right to publish, use, and sell a literary, musical, or
artistic work.
• Legal life is the life of the creator plus 70 years.
Technology:
• Website development: Capitalize the costs of acquiring a domain
name and developing graphics.
• Software: Capitalize the direct costs of developing software (coding
and testing) after the software is technologically feasible. Amortize
any costs related to software that is to be sold or leased to
customers. Test the software annually for impairment. Costs
incurred during the preliminary concept phase should be expensed.

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Common Intangibles (3 of 4)
Research & Development Costs:
• Research and development costs are not capitalized as an
intangible asset due to uncertainty as to future benefits.
• These costs should be expensed and recorded on the income
statement.

Patents:
• A patent is an exclusive right granted by the federal government
for 20 years for inventions and new processes.
• Owner can use, manufacture, and sell both the subject of the
patent and the patent itself.
• If internally developed, only the registration fees and legal costs
are capitalized (recorded as an asset).

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Common Intangibles (4 of 4)
Franchises:
• Franchises may be granted by the government or a company for a
specific period and purpose.
• Franchise agreements are contracts.
• They usually require an investment by the franchisee;
therefore, they should be accounted for as intangible assets.
• The life of the franchise agreement depends on the contract and
can be for a single year or indefinite period.

Licenses and operating rights:

• These intangible assets are the permissions to use a product or
service according to specific terms and conditions.

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Chapter Supplement:
Changes in Depreciation Estimates (1 of 3)
Chapter
Supplement

Depreciation is based on two estimates:

ESTIMATED ESTIMATED
useful life residual value

If the estimates change, then the undepreciated asset balance (less

any residual value at the date of the change) should be depreciated
over the remaining useful life.

If improvements are made that extend the assets useful

life, the depreciation must also be recalculated.

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Chapter Supplement: Changes in Depreciation
Estimates (2 of 3)
Chapter
Supplement
To compute the new depreciation expense due to a
change in estimate, substitute:
• the net book value for the original acquisition cost,
• the new residual value for the original amount, and
• the estimated remaining life in place of the original
estimated life.

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Chapter Supplement: Changes in Depreciation Estimates (3 of 3)
 FedEx purchased an aircraft for $60 million with an estimated useful
life of 20 years and estimated residual value of $3 million.
 In year 5, FedEx changed the estimated useful life to 25 years and
lowered the residual value to $2.4 million.
 Calculate depreciation expense for the fifth year using the straight-
line method.

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