Days 14&15 Long-lived Assets

1. Definition of long-lived assets

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1. Definition of Long-lived Assets
Long-lived assets meeting the following criteria:
a) they are held for use in the normal course of operations (e.g.,
production or supply of goods and services).
b) have been acquired, constructed or developed with the
intention of being used on a continuing basis.
c) are not intended for sale in the ordinary course of business.
Types of capital assets
Tangible: have a physical existence, e. g., property, plant &
equipment (PPE), natural resources.
Intangible: no physical existence, value comes from rights
conferred upon holder, e. g., brand names, trademarks,
patents, copyrights, licenses.

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2. Valuation at Initial Acquisition
Cost is the amount of consideration given up to get the asset,
including all costs required to install the asset at the location
and in the condition necessary for its intended use.
These costs may include:
❖ purchase price
❖ construction costs
❖ transportation costs
❖ duties and taxes, legal fees
❖ architectural, design and engineering fees
❖ site preparation costs, including any demolition
❖ interest cost on loans to finance construction
❖ installation costs, including testing

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Acquisition Cost Example
Machine 101 was purchased and put into operation on July 31.
The following items and expenditures were noted:
Invoice cost $19,000
Cash discount received (2%) 380
Transportation charges 570
Operator wages (August) 975
Installation/testing costs 950
Insurance premium (1 yr) 450
What was the cost of Machine 101?

If insurance covered installation period, part of premium

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 3. Depreciation
Since long-lived assets provide benefits over several years, the
cost of a depreciable asset is allocated to the periods in which
the asset is used and revenues are generated by its use.
Depreciation expense is the amount of depreciation recorded
each period and should be reported on the statement of income.
Accumulated depreciation represents the total amount of
depreciation expense that has been recorded for an asset since
the asset was acquired. It is reported on the statement of
financial position as a contra-asset account.
Assets with an indefinite useful life (e. g., land, some
intangibles) are not subject to depreciation.

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 Depreciation Method
1. Determine acquisition cost
= purchase price + any expenditures reasonable and
necessary to put the asset into service.
2. Estimate useful life and residual value (expected value at
end of useful service life). Note that the asset’s physical life
may extend beyond its useful life.
3. Decide upon the pattern of revenue generation of asset (i.
e., select a depreciation method):
❖ Straight-line
❖ Diminishing-balance
❖ Units-of-production

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 Depreciation Method
Straight line method
Depreciation expense
= Net cost /Useful life
Net cost = Cost - Residual value
❖ simple and easy to use.
❖ by far the most popular depreciation method.
❖ depreciation expense is the same in every year (except
perhaps years of acquisition and disposal).
❖ appropriate if asset provides constant level of benefits
throughout its useful life.

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 Depreciation Method
Diminishing-balance
Depreciation expense
= Carrying value × depreciation rate
Carrying value = Cost – Accumulated depreciation
❖ a type of “accelerated” depreciation, generating higher
expense in early years of the asset’s life.
❖ Appropriate if asset efficiency and earning power
decline as the asset ages.
❖ Popular form is double-diminishing-balance, where
depreciation rate = (1/useful life in years) × 2.

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 Depreciation Method
Units-of-production
Depreciation expense
= Units of activity realized this period × depreciation rate per unit
Depreciation rate per unit
= (cost - residual value)/estimated total units of activity.
Units of activity is a measure of capacity of the asset, either in terms
of service (e. g., hours of operation, kilometers) or production (e. g.,
finished goods produced).
❖ Under this method, the periodic depreciation expense increases
and decreases with the asset’s use. Therefore, this method
provides the best matching of the cost of the asset with the
benefits derived from it.

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Depreciation Method Example
Machine Ltd purchased a machine on June 30, 2017 for
$50,000. It is estimated that the machine will have a
$10,000 residual value at the end of its service life of 10
years (or approximately 10,000 operating hours).
Depreciation is computed to the nearest month. Compute
depreciation expense for 2017 and 2018 (assume a
December 31 fiscal year end) using each of the following
methods:
a) straight-line
b) units-of-production based on working hours (hours of
operation were 1,000 in 2017 and 1,500 in 2018)
c) double-diminishing balance

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Depreciation Method Example

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Depreciation Method Example

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4. Changes in Depreciation
Companies may (and should) periodically revise
estimates used in the depreciation calculation.
Specifically, the estimated residual value may change; the
estimated useful life may need to be revised; or the
pattern of use of the asset might change, implying the
need to change the depreciation method.
Accounting for a change in estimate is done prospectively
(i. e., there are no changes in previous years’
depreciation). The appropriate treatment is to depreciate
the remaining book value less the revised estimate of the
residual value over the (updated) remaining useful life.

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Changes in Depreciation Example
The G and S Moving Company has one truck, whose original cost
was $23,000. Its estimated residual value was $3,000 and its
estimated useful life was 4 years. At the beginning of year 3, its net
book value was $13,000 (G&S uses straight-line method). After
reviewing the use and current condition of the vehicle, the company
now believes that the total useful life of the truck will be 5 years,
after which its estimated residual value will be $1,000.
Required
Show the entries to record depreciation expense for year 3.

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5. Costs Incurred Subsequent to
Acquisition
Costs of ordinary repairs/maintenance (i. e., that are
necessary to maintain a long-lived asset in normal
operating condition) are classified as operating
expenditure (reported on the statement of income).
Costs incurred subsequent to the acquisition of an asset
should be classified as capital expenditure (added to the
book value of the asset) if they create likely additional
future benefits by either:
❖ extending the asset’s useful life or
❖ increasing the asset’s productivity.

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Costs Incurred Subsequent to
Acquisition
What is the appropriate accounting treatment for
each of the following costs?
1. A small fried chicken franchise has a car that it
uses for deliveries, with an expected useful life of
5 years. After 3 months, the company has a $50
oil change done.

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Costs Incurred Subsequent to
Acquisition
What is the appropriate accounting treatment for each of the
following costs?
2. A building with an estimated useful life of 20 years
gets a new roof (cost = $25,000) at the end of year 15.
The usefulness of the building has not changed, but
the estimated useful life of the building is revised to
30 years.

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6. Derecognition
Derecognition of an asset means removal of an asset from the
company’s accounting records. Derecognition occurs when:
❖ The company disposes of the asset through sale; or
❖ No future benefit is expected from the asset (retired).

On derecognition, the entity must:

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Derecognition Example
A company sells a car (cost = $22,000; accumulated
depreciation = $8,000) for $17,000. The journal entry is:

If the company had received $12,000:

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7. Alpha Company Example
Part A: Alpha company purchased new premises on January
1, 2017. It paid a lump sum of $450,000 for the land and
the building (appraised values of the land and building were
$150,000 and $350,000, respectively). Before relocating to
the new premises, renovations of $50,000 were made to the
building. The useful life of the building is estimated to be
25 years with a residual value estimated to be $5,000.
Required
Calculate depreciation expense for the year ended Dec. 31,
2018, using (i) straight-line and (ii) double-diminishing
balance methods.

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Alpha Company Example

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Alpha Company Example

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8. Fast and Slow Corporations Example
Fast and Slow corporations just disposed of identical
machines that each had purchased two years ago for
$16,000 (useful life = 8 years; expected residual value =
0). Slow sold its machine for $11,500, $500 more than
Fast got for their machine. Fast, however, recorded a
$2,000 gain on the disposal whereas Slow posted a $500
loss.
Required
1. Prepare the journal entries made by each firm to
record the disposal of the machines.
2. Which depreciation method did each firm use?
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Fast and Slow Corporations Example

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Fast and Slow Corporations Example

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