Week 9

ACCT 6301
FALL 2019

10/12/2019 ©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 1

 Tonight’s
Topics
Chapter 8 Lecture

10/12/2019 ©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 2

Chapter 8 – Reporting
and Analyzing Long
Term Assets
ACCT 6301 – FINANCIAL ACCOUNTING – FALL 2019

10/12/2019 ©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 3

 Describe and
distinguish
Learning Objective
LEARNING between
tangible and
OBJECTIVE 1

intangible
assets.
©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 4
 Two common characteristics:
1. Acquired for the purpose of
Long-Term producing and delivering products
Operating Assets and services that generate revenues
2. Help produce revenues for multiple
periods

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS

5
Long-Term Operating Assets
Tangible Assets
• Have physical substance
• Usually include land, buildings, machinery, fixtures and equipment

Intangible Assets
• Have no physical substance
• Provide the owner with specific rights and privileges
• Include trademarks, patents, copyrights

™ © ℗ ®
©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 6
Walmart’s Operating Assets
Walmart reports its operating assets in two categories in the property,
plant, and equipment section of its balance sheets:
Assets (in millions) Jan. 31, 2019 Jan. 31, 2018
Property and equipment:
Property and equipment $185,810 $185,154
Less accumulated depreciation (81,493) (77,479)
Property and equipment, net $104,317 $107,675
Property under capital leases:
Property under capital leases $12,760 $12,703
Less accumulated amortization (5,682) (5,560)
Property under capital leases, net $7,078 $7,143

Book value

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 7

 Determine
which costs to
Learning Objective
LEARNING capitalize and
report as assets
OBJECTIVE 2

and which costs

to expense.
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Capitalized Costs
• Reported as assets on the balance sheet
• Called capital expenditures
• Must include all costs necessary to acquire an asset and prepare
it for its intended use
• Includes:
• Installation costs
• Taxes
• Shipping costs (freight)
• Legal fees
• Setup and calibration costs
• Asset retirement obligations

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 9

Capital Expenditure
Characteristics
Characteristics that expenditures must possess to be capitalized:

1. The asset must be owned or controlled by the company.

2. The asset must be expected to provide future benefits.
◦ Must be directly linked to future benefits

Capitalized costs cannot exceed the expected future benefits to be derived from the use of the asset.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 10

Constructed Assets
When assets are constructed by a company for its own use, capitalized costs
should include:

• All direct material and labor costs, and

• A reasonable amount of overhead costs, and
• Capitalized interest
• Interest expenses associated with debt incurred to finance the construction
• Only if specific criteria are met

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 11

 Additional costs incurred after an asset is placed in
service:

Improvement or betterment
Costs • Consist of outlays that enhance the usefulness of
Subsequent the asset or extend the asset’s useful life beyond
the original expectation
to
• Costs should be capitalized
Acquisition
Routine repairs and maintenance
• Expensed in the period incurred

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Depreciation
• Cost of PPE assets is allocated systematically to expense over the time period
that the assets are expected to help produce revenue
• Cost allocation process is known as depreciation
• Cost transferred from the balance sheet to the income statement

Depreciation is a systematic allocation

of the cost of an asset to expense over time.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 13

Purchase of PPE
1) Acquired a delivery truck for $80,000 cash.
  Balance Sheet   Income Statement
Transaction Cash + Noncash = Liabilities + Contrib. + Earned   Revenues – Expenses = Net
Asset Asset Capital Capital Income
Acquired a –80,000 +80,000  
delivery truck Cash Truck = ‒ =
for $80,000
cash

(1) Truck (+A) 80,000  

Cash (–A)   80,000

Cash (A) Cash (A)

(1) 80,000 80,000 (1)

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Recording Depreciation
2) Recorded depreciation of $12,000 for the delivery truck.

Cash Noncash Contra Contrib. Earned Net

Transaction Asset + Asset – Asset = Liabilities + Capital + Capital   Revenues – Expenses = Income
Depreciation +12,000 +12,000   +12,000 –12,000
of the Accumulated = Retained ‒ Depreciation =
delivery truck Depreciation Earnings Expense

(2) Depreciation expense (+E, –SE) 12,000  

Accumulated depreciation (+XA, –A)   12,000

Depreciation Expense (E) Accumulated Depreciation (XA)

(2) 12,000 12,000 (2)

Represents the total asset cost expensed since acquired

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 15

 Plant Assets on the Balance
Sheet
Delivery truck, at cost $ 80,000
Less accumulated depreciation (12,000)
Delivery truck, net $ 68,000

Over time the contra asset grows while net value declines.

Accumulated Depreciation
• Contra asset account
• Represents the total cost allocated to expense since the asset was acquired
• Offsets the balance in the corresponding asset account

Book Value
• Remaining cost that is not yet depreciated

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 Apply different
depreciation
Learning Objective
LEARNING methods to
allocate the
OBJECTIVE 3

cost of assets
over time.
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Depreciation Methods –
Estimates Required
Useful Life
• The period of time over which the asset is expected to provide economic
benefits to the company
• Differs from the physical life

Residual Value
• The expected realizable value of the asset at the end of its useful life
• Also known as salvage value
• Can represent the scrap, disposal, or resale value

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Three Common Depreciation
Methods
Straight-line method
• Equal expense each year

Double-declining-balance method
• Accelerated method—more expense in early years

Units-of-production method
• Based on activity instead of time
All three methods expense the non-recoverable cost of an asset.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 19

Straight-Line Depreciation—
Example
Tanner Enterprises purchased a delivery truck for $80,000, and estimated the useful life
to be 5 years and the residual value to be $8,000.

Depreciation Base Depreciation Rate

Cost – Residual value 1 ÷ Estimated useful life
$80,000 – $8,000 = $72,000 1 ÷ 5 years = 20%

Depreciation expense = Depreciation base x Depreciation rate

$72,000 × 20% = $14,400

Book value at end of year 1:

$80,000 – $14,400 = $65,600

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 20

Double-Declining-Balance
Depreciation—Example
Tanner Enterprises purchased a delivery truck for $80,000, and estimated the useful life to be
5 years and the residual value to be $8,000.
Depreciation Base Depreciation Rate
Cost – Accumulated depreciation 2 x SL rate = 2 x 20% = 40%

Book Value at Book Value at

Year Beginning of Year Depreciation Expense End of Year
1 $80,000 $80,000 × 40% = $32,000 $48,000
2 48,000 $48,000 × 40% = $19,200 28,800
3 28,800 $28,800 × 40% = $11,520 17,280
4 17,280 $17,280 × 40% = $6,912 10,368
5 10,368 $10,368 – $8,000 = $2,368 8,000

The 40% rate is not used in the last year because it would reduce the net book
value below the residual value.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 21

Comparing Depreciation
Methods
Because double-declining-balance is an accelerated method, the expense in the early years’ of
life is larger than in its latter years.

Straight-Line Double-Declining-Balance
Book Value Book Value
Year Depreciation Expense at End of Year Depreciation Expense at End of Year
1 $14,400 $65,600 $32,000 $ 48,000
2 14,400 51,200 19,200 28,800
3 14,400 36,800 11,520 17,280
4 14,400 22,400 6,912 10,368
5 14,400 8,000 2,368 8,000
$72,000 $ 72,000

Total depreciation over the asset ‘s All depreciation methods yield

life is identical for all methods. the same residual value.

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Units-of-Production Depreciation
—
Example
Tanner Enterprises purchased a delivery truck for $80,000, and estimated the truck would
provide 80,000 miles of service before it is sold for its residual value of $8,000. The truck was
driven 18,000 miles in Year 1.

Depreciation Base Depreciation Rate

Cost – Residual value Depreciation Base ÷ Units of Service
$80,000 – $8,000 = $72,000 $72,000 ÷ 80,000 = $0.90 per mile

Depreciation expense = Actual units of service x Depreciation rate

$18,000 × $0.90 = $16,200

Book value at end of year 1:

$80,000 – $16,200 = $63,800

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Changes in Accounting Estimates
• Estimates of useful lives and residual value are made when assets are
acquired
• When necessary, companies can change estimates
• Changes are applied prospectively (i.e., only to future accounting periods)

2019 2020 2021

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Changes in Accounting Estimate
—
Example
Tanner Enterprises decided to extend the useful life of the truck from 5 to 7 years after
completing 4 years of service. Straight-line depreciation is used. (Note that the residual value
estimate does not change.)
Step 1: Determine the book value at the date of estimate change.
Cost – Accumulated depreciation = Book value
$80,000 – ($14,400 × 4 years) = $22,400
Step 2: Determine the new remaining useful life.
Original life – Years depreciated + Additional years
5 years – 4 years + 2 years = 3 years
Step 3: Determine depreciation expense for Year 5.

Book Value – Residual value $22,400 - $8,000

= = $4,800
Remaining estimated life 3 years

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 Determine the
effects of asset
Learning Objective
LEARNING sales and
impairments
OBJECTIVE 4

on financial
statements.
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Gains and Losses on Asset Sales
Selling long-term assets:
• Produces a gain if the proceeds are greater than the book value of the asset
• Produces a loss if the proceeds are less than the book value of the asset
• Gains and losses can be reported in income:
• From continuing operations or,
• If applicable, as discontinued operations

Proceeds from Asset Sale

– Book Value of Asset Sold
= Gain or Loss on Asset Sale

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Gain or Loss on Asset Sale—
Example
Tanner Enterprises decided to sell the $80,000 truck for $25,000 after 4 years of straight-line
depreciation. The truck’s estimated useful life was 5 years and its residual value was $8,000.

Book value = Cost – Accumulated depreciation

$80,000 – ($14,400 x 4) = $22,400

Proceeds $25,000 – Book value $22,400 = $2,600 Gain

Gains and losses are usually nonrecurring components

of income from continuing operations.

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Recording Gains or Losses
on Asset Sales
To record the sale:

1. Remove the cost of the disposed asset from the balance sheet asset account (i.e., a
credit to the asset account).
2. Remove the depreciation related to the disposed asset from the accumulated
depreciation balance sheet account (i.e., a debit to accumulated depreciation).
3. Record the proceeds as an increase in cash (i.e., debit the cash account).
4. Record the gain (credit) or a loss (debit) on the income statement.

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Recording
the Sale of an Operating Asset
3) Recorded the sale of the delivery truck for $25,000.

Cash Noncash Contra Contrib. Earned Net

Transaction Asset + Asset – Asset = Liabilities + Capital + Capital   Revenues – Expenses = Income
Sold the +25,000 –80,000 –57,600 +2,600   +2,600 +2,600
delivery truck Cash Truck Accumulated = Retained Gain on ‒ =
for $25,000 Depreciation Earnings Sale of
Truck

(3) Cash (+A) 25,000  

Accumulated depreciation (+A, –XA) 57,600
Truck (–A)   80,000
Gain on sale of truck (+R, +SE) 2,600

Cash (A) Accumulated Depreciation (XA)

(3) 25,000 (3) 57,600

Truck (A) Gain on Sale of Truck (R)

80,000 (3) 2,600 (3)

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Asset Impairments
Companies must recognize losses on assets if impairment exists.

When does impairment exist?

• When market values of long-term assets decline to less than book value, and
• It can be determined that the asset’s value is permanently impaired

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Impairment Analysis
of Long-Term Assets
Impairment Analysis of Long-Term Assets

After an impairment write-down, depreciation charges are reduced

by the write off.

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Recording an Asset Impairment
The impairment write-down reduces assets by the amount of the write-down
and a loss is recognized on the income statement.

Financial Statement Effects of Asset Impairment

Write-downs of long-term assets are often recognized in connection with a

restructuring program.

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Potential Challenges
of Asset Impairments
Analysis of asset write-downs present two potential challenges:

Insufficient Write-Down
Assets sometimes are impaired to a larger degree than is actually recognized.

Aggressive Write-Down
The “big bath” scenario can arise if income is currently and severely depressed.

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IFRS Reporting Insight -
Impairment
A Single-step process is used:

• Compare asset’s balance-sheet carrying value to the asset’s recoverable

amount
• Recoverable amount = Higher of:
• Fair value, or
• Asset’s value in current use (present value of its future cash flows from current use)
• Excess is the amount of impairment
• Impairment loss is included in income
• Asset can be revalued upward to fair value if fair value can be reliably
measured

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Walmart’s Footnote Disclosure
Walmart reported the following disclosure for its property and equipment for
its year ending January 31, 2019:

Property and equipment are initially recorded at cost. Gains or losses on

disposition are recognized as earned or incurred. Costs of major
improvements are capitalized, while costs of normal repairs and
maintenance are charged to expense as incurred. The following table
summarizes the Company’s property and equipment balances and
includes the estimated useful lives that are generally used to depreciate
the assets on a straight-line basis:

Estimated Useful Lives Depreciation Method

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PPE Turnover (PPET)
Measures how efficient management utilized its plant assets.

PPET = Sales revenue

Average PPE, net
Applying the PPE Turnover ratio to Procter & Gamble:
2016: $65,299 / $19,520 = 3.35
P&G generates about four times as
2017: $65,058 / $19,639 = 3.31 much sales revenue as its investment
in PPE.
2018: $66,832 / $20,247 = 3.30

2018 PPET decreased slightly relative to 2016 levels.

Higher PPET is preferred; it implies a lower level of capital investment required to
achieve a given level of sales revenue.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 37

Comparison of PPE Turnover
PPE Turnover at P&G and a Competitor:

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Comparison of PPE Turnover
PPE Turnover for companies in different industries:

We see that PPET differs considerably by industry.

Capital intensive businesses with long-lived assets like Delta Air Lines and Verizon
Communications have a low ratio.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 39

Percent Depreciated
Measures the percent of a company’s operating assets that have been
depreciated.

Percent Accumulated depreciation

=
depreciated Cost of depreciable asset*
Applying the Percent Depreciated ratio to P&G:
2016: $20,481 / $36,391 = 56.3%
2017: $20,255 / $36,448 = 55.6%
2018: $21,247 / $37,783 = 56.2%

P&G’s operating assets are slightly over 50% depreciated, likely due to the mix of
new assets and those nearing the end of their useful life.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 40

Percent Depreciated
Percent Depreciated for Procter & Gamble and a Competitor:

Procter & Gamble Colgate-Palmolive Company

Year (Year End 6/30) (Year End 12/31)
2018 56.2% 54.4%
2017 55.6% 52.9%
2016 56.3% 52.6%

Both are mature companies experiencing long-term steady growth. They acquire
assets on a continuing basis and, as a result, they have some assets that are brand-
new and others that are reaching the end of their productive lives.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 41

Percent Depreciated
Percent Depreciated for companies in different industries:

Companies’ percent depreciated ratio may differ because they are using different
depreciation methods (straight-line or accelerated), because they have chosen
different useful lives for their assets, or because they have older (or newer) assets.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 42

Effects on Statement of Cash
Flows
Acquisition of plant or equipment
• Reported as a use of cash in the investment section
Cash received from asset sales
• Reported as a source of cash in the investment section

Investing section of Walmart’s statement of cash flows for the year ended January 31, 2019:
Jan. 31, 2019

Cash flows from investing activities:

Payments for property and equipment ($10,344)

Proceeds from the disposal of property and equipment 519

Proceeds from the disposal of certain operations 876

Other investing activities ( 15,087)

Net cash used in investing activities ($24,036)

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 43

 Describe the
accounting
Learning Objective
LEANRING
OBJECTIVE 5 and reporting
for intangible
assets.
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Intangible Assets – Two Categories
Separately Transferable Intangibles
• Those that are the product of contractual or other legal rights
℗
• Those that are not contractually or legally defined, but can be ©
separated from the company and sold, transferred, or
™
®
exchanged

Not Separately Transferable Intangibles (Goodwill)

• The excess of cost over the fair value of net assets acquired in
a business combination

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 45

Accounting for Intangible Assets
• Can be purchased from another company or individual, or internally
developed
• Purchase cost is capitalized

• Internally developed costs are generally expensed as incurred

• (Example: research and development costs)

Problems with accounting for intangibles:

• Benefits provided by intangibles are uncertain and difficult to quantify

• Useful life often impossible to estimate with confidence

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 46

Patents
What is a patent?
• An exclusive right to produce a product or use a technology
• Granted to protect the inventor by preventing other companies from

℗
copying the innovation
Accounting for costs of patents:
• If purchased from another company, costs are capitalized and amortized
• If developed internally, only legal costs and registration fees are
capitalized and amortized

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 47

Copyrights
What is a copyright?
• An exclusive right granted by the government to an individual author,

©
composer, play writer, or similar individual
• For the life of the creator plus 70 years
• Can be acquired
• Cost is capitalized and amortized over the expected remaining economic
life

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 48

Trademarks
What is a trademark?
• A registered name, logo, package design, image, jingle, or slogan that is
associated with a product
Accounting for costs of trademarks:
• If purchased from another company:
• Capitalize the cost and amortize
TM
• If developed internally:
• Expense as incurred

All advertising costs are expensed as incurred, even if the value of a

trademark is enhanced by the advertising.
®
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The NIKE Trademark
In the early 1970’s, Carolyn Davidson, a graduate student studying graphic design,
created the Nike swoosh for Phil Knight, owner of Blue Ribbon Sports. Phil was seeking
a new logo and asked Carolyn to create a design. Phil chose the now popular ‘swoosh’
logo and paid Carolyn’s invoice of approximately $35 for her work.*

Source: Nikebiz: Company Overview: History, 1970s. “The Birth of the Nike Brand, and Company.” http://www.nikebiz.com/company_overview/history/1970s.html

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Franchise Rights
What is a franchise right?
• A contractual agreement that gives the right to operate a particular business in an
area for a particular period of time
• Cost generally includes start-up costs & franchise fees

How much does it cost to open a

Moe's Southwest Grill® franchise?*
Total Investment: $453,215-$787,493 Term of Agreement: 20 years
Initial Franchise Fee: $30,000 Renewal Fee: Then-current franchise fee
Royalty Fee: 5%

*Source: http://www.thefranchisemall.com/franchises/details/11138-0-moes_southwest_grill.htm

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Amortization of Intangible Assets
Amortization for intangible assets that have a definite life
• Capitalized cost is amortized over the expected useful life of the intangible
• Amortization is a systematic allocation of the cost of an intangible asset over
its useful life
• Straight-line method used most often
• Amortization expense reported on the income statement as part of operating
income
• Often included with selling, general, and administrative expenses

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Purchasing a Patent
1) Moe’s Southwest Grill® spent $80,000 at the beginning of the year to purchase a patent.
The patent has a remaining legal life of 10 years, but the management at Moe’s believe its
will provide benefits for only 5 more years.

Cash Noncash Contra Contrib. Earned Net

Transaction + – = Liabilities + +   Revenues – Expenses =
Asset Asset Asset Capital Capital Income
Purchased –80,000 +80,000
patent Cash Patent = ‒ =

(1) Patent (+A) 80,000  

Cash (–A) 80,000

Patent (A) Cash (A)

(1) 80,000 80,000 (1)

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Recording Amortization
of Intangible Assets—Definite
Life
2) Moe’s Southwest Grill® spent $80,000 at the beginning of the year to purchase a patent.
The patent has a remaining legal life of 10 years, but the management at Moe’s believe its
will provide benefits for only 5 more years.
$80,000 ÷ 5 years = $16,000
Transaction Cash + Noncash – Contra = Liabilities + Contrib. + Earned   Revenues – Expenses = Net
Asset Asset Asset Capital Capital Income
Amortized +16,000 –16,000 +16,000 –16,000
patent Accumulated = Retained ‒ Amortization =
Amortization Earnings Expense

(2) Amortization expense (+E, –SE) 16,000  

Accumulated amortization (+XA, –A) 16,000

Amortization Expense (E) Accumulated Amortization (XA)

(2) 16,000 16,000 (2)

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Intangibles With Indefinite Lives
• Expected useful life of some intangibles extends far enough into the future
that it is impossible for management to estimate
• Not amortized until the useful life can be specified
• Must be tested for impairment annually
• Considered to be impaired if the book value of the asset exceeds its fair value
• Write-down equal to:
Book value – Fair value

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 55

Recording the Impairment
of Identifiable Intangible Assets
After 5 years of operations, changes in regulation caused SatCo’s $62,000 trademark to become
permanently impaired. Management determined the trademark’s fair value was $40,000 and its
book value was $62,000.
$80,000 ÷ 5 years = $16,000
Transaction Cash + Noncash – Contra = Liabilities + Contrib. + Earned   Revenues – Expenses = Net
Asset Asset Asset Capital Capital Income
Record asset –22,000 –22,000 +22,000 –22,000
impairment Trademark = Retained ‒ Loss =
Earnings Due to
Impairment
of
Trademark

Loss due to impairment of trademark (+E, –SE) 22,000  

Trademark (–A) 22,000

Loss Due to Impairment (E) Trademark (A)

22,000 22,000

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Goodwill
What is goodwill?
• The excess of the purchase price paid over the fair value of its identifiable net
assets to buy an entire company
• Net assets = Assets – Liabilities assumed
Purchase of
the net assets
Company A Company B

• Cannot be separated from the acquired company or sold separately

• Has an indefinite life
• Never amortized
• Subject to impairment of value
©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 57
Target’s Footnote Disclosure
Excerpts from Target Corporation’s 2018 annual report include:

Goodwill and Intangible Assets

Goodwill totaled $633 million and $630 million at February 2, 2019 and February 3,
2018, respectively…. No impairments were recorded in 2018, 2017 or 2016 as a result
of the goodwill impairment tests performed….

We use both accelerated and straight-line methods to amortize definite-lived

intangible assets 4 to 15 years. The weighted average life of intangible assets was 8
years, at February 2, 2019. Amortization expense was $14 million, $14 million and
$13 million in 2018, 2017 and 2016, respectively and is estimated to be less than $15
million annually through 2023.

©2020 JEFFREY KROMER AND CAMBRIDGE BUSINESS PUBLISHERS 58

 Analyze the
effects of
tangible and
Learning Objective
LEARNING
OBJECTIVE 6 intangible assets
on key
performance
measures.
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Financial Statement Analysis
Implications
Hidden assets
• Internally generated intangible assets are not capitalized (i.e., expensed)
• Uncapitalized assets do not appear on financial statements
• Analysis of financial statements can be distorted
• Creates an upward bias in asset turnover ratios and ROE
• Makes comparison of companies difficult for users

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