6 Derecognition of Property, Plant, and Equipment

8.6. Derecognition of Property, Plant, and Equipment



197



Recall the calcula on of straight-line deprecia on for the equipment purchased for $20,000 with

an es mated useful life of five years and a residual value of $2,000. Assume that the general ledger

T-accounts of equipment and accumulated deprecia on contain the following entries for the last

five years:



2015



Equipment

20,000



Accumulated Deprecia on

Equipment

2015

3,600

2016

3,600

2017

3,600

2018

3,600

2019

3,600

18,000



Assume that the equipment is sold at the end of 2019, when accumulated deprecia on totals

$18,000. The carrying amount at this date is $2,000 ($20,000 cost – $18,000 accumulated deprecia on). Three different situa ons are possible.

1. Sale at carrying amount

Assume the equipment is sold for its residual value of $2,000. No gain or loss on disposal

would occur.

Cost

Accumulated deprecia on

Carrying amount

Proceeds of disposi on

Gain on disposal



Date



$



$



General Journal

Account/Explana on

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accumulated Dep. – Equipment . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . .

To record the disposal of equipment sold

for $2,000 cash.



20,000

(18,000)

2,000

(2,000)

-0-



PR



Debit

2,000

18,000



Credit



20,000



2. Sale above carrying amount

Assume the equipment is sold for $3,000. A gain of $1,000 would occur.

Cost

Accumulated deprecia on

Carrying amount

Proceeds of disposi on

Gain on disposal



$



$



20,000

(18,000)

2,000

(3,000)

(1,000)



198



Long-lived Assets



Date



General Journal

Account/Explana on

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accumulated Dep. – Equipment . . . . . . . . .

Gain on Disposal . . . . . . . . . . . . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . .

To record the disposal of equipment sold

for $3,000 cash.



PR



Debit

3,000

18,000



Credit



1,000

20,000



3. Sale below carrying amount

Assume the equipment is sold for $500. A loss on disposal of $1,500 would occur.

Cost

Accumulated deprecia on

Carrying amount

Proceeds of disposi on

Loss on disposal



Date



$



$



General Journal

Account/Explana on

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accumulated Dep. – Equipment . . . . . . . . .

Loss on Disposal . . . . . . . . . . . . . . . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . .

To record the disposal of equipment sold

for $500 cash.



20,000

(18,000)

2,000

(500)

1,500



PR



Debit

500

18,000

1,500



Credit



20,000



In each of these cases, the cash proceeds must be recorded (by a debit) and the cost and accumulated deprecia on must be removed from the accounts. A credit difference represents a gain on

disposal while a debit difference represents a loss.



An explora on is available on the Lyryx system. Log into your Lyryx course to run Disposal

of PPE Assets.



Disposal Involving Trade-In

It is a common prac ce to exchange a used PPE asset for a new one. This is known as a trade-in.

The value of the trade-in agreed by the purchaser and seller is called the trade-in allowance. This

amount is applied to the purchase price of the new asset, and the purchaser pays the difference.

For instance, if the cost of a new asset is $10,000 and a trade-in allowance of $6,000 is given for

the old asset, the purchaser will pay $4,000 ($10,000 – 6,000).



8.6. Derecognition of Property, Plant, and Equipment



199



Some mes as an inducement to the purchaser, the trade-in allowance is higher than the fair value

of the used asset on the open market. Regardless, the cost of the new asset must be recorded at

its fair value, calculated as follows:

Cost of new asset = Cash paid + Fair value of asset traded

If there is a difference between the fair value of the old asset and its carrying value, a gain or

loss results. For example, assume again that equipment was purchased by BDCC for $20,000 and

has accumulated deprecia on of $18,000 at the end of 2019. It is traded on January 1, 2020

for new equipment with a list price of $25,000. A trade-in allowance of $2,500 is given on the

old equipment, which has a fair value of only $1,800. In this case, the cost of the new asset is

calculated as follows:

Cash paid

$22,500



+ Fair value of asset traded = Cost of new asset

+ 1,800

= $24,300



Cash paid will equal the difference between the selling price of the new equipment less the tradein allowance, or $22,500 ($25,000 - 2,500). The fair value of the asset traded-in is $1,800. The

cost of the new asset is therefore $24,300 ($23,000 + 1,800). There will be a loss on disposal of

$200 on the old equipment, calculated as follows:

Cost

Accumulated deprecia on

Carrying amount

Fair value

Loss on disposal



$



$



20,000

(18,000)

2,000

(1,800)

200



The journal entry on January 1, 2020 to record the purchase of the new equipment and trade-in

of the old equipment is:

Date



General Journal

Account/Explana on

Equipment (new) . . . . . . . . . . . . . . . . . . . . . .

Accumulated Dep. – Equipment (old) . . . .

Loss on Disposal . . . . . . . . . . . . . . . . . . . . . . .

Equipment (old) . . . . . . . . . . . . . . . . . . . .

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

To record trade-in.



PR



Debit

24,300

18,000

200



Credit



20,000

22,500



By this entry, the cost of the new equipment ($24,300) is entered into the accounts, the accumulated deprecia on and cost of the old equipment is removed from the accounts, and the amount

of cash paid is recorded. The debit difference of $200 represents the loss on disposal of the old

equipment.



200



Long-lived Assets



An explora on is available on the Lyryx system. Log into your Lyryx course to run Exchange

of PPE Assets.



8.7



Intangible Assets



LO7 – Explain and

record the acquisi on and amor za on of intangible assets.



Another major category of long-lived assets that arises from legal rights

and does not have physical substance is that of intangible assets. The

characteris cs of various types of intangible assets are discussed below.



Patents

A patent is an intangible asset that is granted when a company has an exclusive legal privilege to

produce and sell a product or use a process for a specified period. This period varies depending

on the nature of the product or process patented, and on the legisla on in effect. Modifica ons

to the original product or process can result in a new patent being granted, in effect extending the

life of the original patent.

Patents are recorded at cost. If purchased from an inventor, the patent’s cost is easily iden fied;

if developed internally, the patent’s cost includes all expenditures incurred in the development of

the product or process, including salaries and benefits of staff involved.



Copyrights

A copyright is another intangible asset that confers on the holder an exclusive legal privilege to

publish a literary or ar s c work. In this case, the state grants control over a published or ar s c

work for the life of the copyright holder (o en the original ar st) and for a specified period a erward. This control extends to the reproduc on, sale, or other use of the copyrighted material.



Trademarks

A trademark is a symbol or a word used by a company to iden fy itself or one of its products in

the marketplace. Symbols are o en logos printed on company sta onery or displayed at company

offices, on vehicles, or in adver sing. A well-known example is Coke®. The right to use a trademark



8.7. Intangible Assets



201



can be protected by registering it with the appropriate agency. The symbol ‘®’ denotes that a

trademark is registered.



Franchises

A franchise is a legal right granted by one company (the franchisor) to another company (the

franchisee) to sell par cular products or to provide certain services in a given region using a specific

trademark or trade name. In return, the franchisee pays a fee to the franchisor. McDonald’s® is

an example of a franchised fast-food chain.

Another example of a franchise is one granted by government for the provision of certain services

within a given geographical loca on: for example, television sta ons and telephone services authorized by the telecommunica ons branch of the state, or garbage collec on authorized within

a given community.

In addi on to the payment of an ini al franchise fee, which is capitalzsed, a franchise agreement

usually requires annual payments. These payments are considered opera ng expenses.



Computer So ware

Computer so ware programs may be developed by a company, patented, and then sold to customers for use on their computers. Produc vity so ware like Microso Office® is an example.

The cost of acquiring and developing computer so ware programs is recorded as an intangible

asset, even if it is stored on a physical device like a computer. However, computer so ware that

is integral to machinery – for instance, so ware that is necessary to control a piece of produc on

equipment – is included as the cost of the equipment and classified as PPE.



Capitaliza on of Intangible Assets

Normally, intangible assets are measured at cost at the me of acquisi on and are reported in

the asset sec on of a company’s balance sheet under the heading “Intangible Assets.” The cost of

an acquired intangible asset includes its purchase price and any expenditures needed to directly

prepare it for its intended use. Only rarely are subsequent expenditures added to the ini al cost

of a purchased intangible asset. Instead, these are expensed as they are incurred.

Intangible assets may also be internally-generated. That is, the en ty may expend resources to

create processes (for example, computer so ware) that will provide future economic benefits to

it. In this case, a dis nc on is made between research expenditures, which by defini on have no

demonstrable future economic benefit and therefore may not be capitalized, and development

expenditures. These may be capitalized if certain criteria are met – for instance, if the product



202



Long-lived Assets



or process has demonstrated technical feasibility, and there is a clear inten on to use or sell the

intangible asset. Detailed discussion of these topics is beyond the scope of this textbook.



Amor za on of Intangible Assets

Plant and equipment assets are depreciated. Intangible assets are also depreciated but the term

used is amor za on instead of deprecia on. Amor za on (of intangible assets) is the systema c process of alloca ng the cost of intangible assets over their es mated useful lives using the

straight-line method.

Like PPE considera ons, useful life and residual value of intangible assets are es mated by management and must be reviewed annually for reasonableness. Any effects on amor za on expense

because of changes in es mates are accounted for prospec vely. That is, prior accoun ng periods’

expenses are not changed.

To demonstrate the accoun ng for intangibles, assume a patent is purchased for $20,000 on July

1, 2015. The entry to record the purchase is:

Date



General Journal

Account/Explana on

Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

To record the purchase of a patent, an intangible asset.



PR



Debit

20,000



Credit

20,000



Assuming the patent will last 40 years with no residual value, and amor za on is calculated to the

nearest whole month, amor za on expense will be recorded at the December 31, 2015 year end

as:

Date



General Journal

Account/Explana on

Amor za on Expense - Patent . . . . . . . . . .

Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

To record amor za on on the patent;

($20,000 – 0)/40 years = $500/year; $500

x 6/12 = $250.



PR



Debit

250



Credit

250



No ce that the Patent account is credited and not accumulated amor za on. When amor zing

intangibles, the intangible asset is credited; there is no accumulated amor za on for intangible

assets.

Impairment losses, and gains and losses on disposal of intangible assets, are calculated and recorded

in the same manner as for property, plant, and equipment.



8.8. Goodwill



203



An explora on is available on the Lyryx system. Log into your Lyryx course to run Intangible

Assets.



8.8



Goodwill



LO8 – Explain

goodwill

and

iden fy where on

the balance sheet

it is reported.



Assume that Big Dog Carworks Corp. purchases another company for $10

million ($10M). BDCC takes over all opera ons, including management

and staff. There are no liabili es. The fair values of the purchased assets

consist of the following:

Patents

Machinery

Total



$2M

$7M

$9M



Why would BDCC pay $10M for assets with a fair value of only $9M? The extra $1M represents

goodwill. Goodwill is the excess paid over the fair value of the net assets when one company

buys another, and represents the value of the purchasee’s ability to generate superior earnings

compared to other companies in the same industry.

Goodwill is the combina on of a company’s assets which cannot be separately iden fied – such as

a well-trained workforce, be er retail loca ons, superior products, or excellent senior managers

– the value of which is recognized only when a significant por on of the business is purchased by

another company.

Recall that among other characteris cs, intangible assets must be separately iden fiable. Because

components of goodwill are not separately iden fiable, goodwill is not considered an intangible

asset. However, it does have future value and therefore is recorded as a long-lived asset under its

own heading of “Goodwill” on the balance sheet.

The detailed discussion of goodwill is an advanced accoun ng topic and beyond the scope of this

textbook.



8.9



Disclosure



LO9 – Describe

the

disclosure

requirements for

long-lived assets

in the notes to

the

financial

statements.



When long-lived assets are presented on the balance sheet, the notes to

the financial statements need to disclose the following:

• details of each class of assets (e.g., land; equipment including separate parts; patents; goodwill)



204



Long-lived Assets



• measurement basis (usually historical cost)

• type of deprecia on and amor za on methods used, including es mated useful lives

• cost and accumulated deprecia on at the beginning and end of the

period, including addi ons, disposals, and impairment losses

• whether the assets are constructed by the company for its own use

(if PPE) or internally developed (if intangible assets).

Examples of appropriate disclosure of long-lived assets were shown in notes 3(d) and 4 of BDCC’s

financial statements in Chapter 4.



Summary of Chapter 8 Learning Objec ves

LO1 – Describe how the cost of property, plant, and equipment (PPE) is determined, and calculate PPE.

Property, plant and equipment (PPE) are tangible, long-lived assets that are acquired for the purpose of genera ng revenue either directly or indirectly. A capital expditure is debited to a PPE

asset account because it results in the acquisi on of a non-current asset and includes any addional costs involved in preparing the asset for its intended use at or a er ini al acquisi on. A

revenue expenditure does not have a future benefit beyond one year so is expensed. The details

regarding a PPE asset are maintained in a PPE subsidiary ledger.



LO2 – Explain, calculate, and record deprecia on using the units-of-produc on,

straight-line, and double-declining balance methods.

Deprecia on, an applica on of matching, allocates the cost of a PPE asset (except land) over the

accoun ng periods expected to receive benefits from its use. A PPE asset’s cost, residual value,

and useful life or produc ve output are used to calculate deprecia on. There are different deprecia on methods. Units-of-produc on is a usage-based method. Straight-line and double-declining

balance are me-based methods. The formulas for calcula ng deprecia on using these methods

are:

Units-of-Produc on



Straight-Line



Double-Declining Balance



Cost − Es mated Residual Value

Es mated Total Units of Produc on



Cost − Es mated Residual Value

Es mated Total Useful Life



Carrying Amount × 2/n

where n = es mated useful life



= Deprecia on Expense/Unit



= Deprecia on Expense/Period



= Deprecia on Expense/Period



Summary of Chapter 8 Learning Objectives



205



Maximum accumulated deprecia on is equal to cost less residual. The carrying amount of a PPE

asset, also known as the net book value, equals the cost less accumulated deprecia on.



LO3 – Explain, calculate, and record deprecia on for par al years.

When assets are acquired or derecognized partway through the accoun ng period, par al period

deprecia on is recorded. There are several ways to account for par al period deprecia on. Two

common approaches are to calculate deprecia on to the nearest whole month or to apply the

half-year rule. The half-year rule assumes six months of deprecia on in the year of acquisi on

and year of derecogni on regardless of the actual date these occurred.



LO4 – Explain, calculate, and record revised deprecia on for subsequent capital

expenditures.

When there is a change that impacts deprecia on (such as a change in the es mated useful life or

es mated residual value, or a subsequent capital expenditure) revised deprecia on is calculated

prospec vely. It is calculated as:

Remaining Carrying Amount − Es mated Residual Value∗

Es mated Remaining Useful Life∗

∗ where the residual value and/or useful life may have changed



LO5 – Explain, calculate, and record the impairment of long-lived assets.

The recoverable amount of a long-lived asset must be compared with its carrying amount (cost

less accumulated deprecia on) at the end of each repor ng period. The recoverable amount is

the fair value of the asset at the me less any es mated costs to sell it. If the recoverable amount

is lower than the carrying amount, an impairment loss must be recorded as:

Date



General Journal

Account/Explana on

Impairment Loss . . . . . . . . . . . . . . . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . .

To record impairment loss.



PR



Debit

XXX



Credit

XXX



Impairment losses can be reversed in subsequent years if the recoverable amount of the asset

exceeds the carrying amount. Also, if the fair value of a PPE asset can be reliably measured, it can

be revalued to more than its original cost.



206



Long-lived Assets



LO6 – Account for the derecogni on of PPE assets.

Property, plant, and equipment is derecognized (that is, the cost and any related accumulated deprecia on are removed from the accoun ng records) when it is sold or when no future economic

benefit is expected. To account for the disposal of a PPE asset, the following must occur:

1. If the disposal occurs part way through the accoun ng period, deprecia on must be updated

to the date of disposal by

Date



General Journal

Account/Explana on

Deprecia on Expense . . . . . . . . . . . . . . . . . .

Accumulated Deprecia on . . . . . . . . . . .

To update deprecia on for par al period.



PR



Debit

XXX



Credit

XXX



2. Record the disposal including any resul ng gain or loss by

Date



General Journal

Account/Explana on

Cash (if any, or other assets received) . . . .

Accumulated Deprecia on . . . . . . . . . . . . . .

Loss on Disposal . . . . . . . . . . . . . . . . . . . . . . .

OR Gain on Disposal . . . . . . . . . . . . . . . .

PPE Asset (such as Equipment) . . . . . . .

To record disposal of PPE asset.



PR



Debit

XXX

XXX

XXX



Credit



XXX

XXX



A loss results when the carrying amount of the asset is greater than the proceeds received, if any.

A gain results when the carrying amount is less than any proceeds received.

It is a common prac ce to exchange a used PPE asset for a new one, known as a trade-in. The

value of the trade-in is called the trade-in allowance and is applied to the purchase price of the

new asset so that the purchaser pays the difference. Some mes the trade-in allowance is higher

than the fair value of the used asset. The cost of the new asset must be recorded at its fair value,

calculated as:

Cost of new asset = Cash paid + Fair value of asset traded

If there is a difference between the fair value of the old asset and its carrying value, a gain or loss

results.



LO7 – Explain and record the acquisi on and amor za on of intangible assets.

Intangible assets are long-lived assets that arise from legal rights and do not have physical substance. Examples include patents, copyrights, trademarks, and franchises. Intangibles are amor-



Summary of Chapter 8 Learning Objectives



207



zed using the straight-line method. The entry to record amor za on is a debit to amor za on

expense and a credit to the intangible asset – there is no accumulated amor za on account.



LO8 – Explain goodwill and iden fy where on the balance sheet it is reported.

Goodwill is a long-lived asset that does not have physical substance but it is NOT an intangible.

When one company buys another company, goodwill is the excess paid over the fair value of the

net assets purchased and represents the value of the purchasee’s ability to generate superior

earnings compared to other companies in the same industry. Goodwill appears in the asset sec on

of the balance sheet under its own heading of “Goodwill”.



LO9 – Describe the disclosure requirements for long-lived assets in the notes to

the financial statements.

When long-lived assets are presented on the balance sheet, the notes to the financial statements

need to disclose the following:

• details of each class of assets (e.g., land; equipment including separate parts; patents; goodwill)

• measurement basis (usually historical cost)

• type of deprecia on and amor za on methods used, including es mated useful lives

• cost and accumulated deprecia on at the beginning and end of the period, including addions, disposals, and impairment losses

whether the assets are constructed by the company for its own use (if PPE) or internally developed

(if intangible assets).