ACTG CH. 6
Double-decling balance depreciation
produces a large amount of depreciation in the first year of an asset's life and progressively smaller levels of expense in each succeeding year **Accelerated depreciation method
Straight line method
produces the same amount of depreciation expense each accounting period
Units of production
produces varying amounts of depreciation expense in different accounting periods
Equipment (determining the cost of long-term assets)
purchase price, sales taxes, delivery costs, installation costs, costs to adapt for intended use
Land (determining the cost of long-term assets)
purchase price, sales taxes, title search and transfer document costs, relator's and attorney's fees, costs for removal of old buildings, and grading costs
Buildings (determining the cost of long-term assets)
purchase price, sales taxes, title search and transfer document costs, relator's and attorney's fees. and remodeling costs
Property, Plant, and Equipment (tangible assets)
sometimes referred to as plant assets or fixed assets. EX: furniture, cash registers, machinery, delivery trucks, computers, mechanical robots, and buildings.
Differences between companies
Depreciation method is not the only aspect of expense recognition that can vary between companies--assumptions about useful lives and salvage values of long-term operation assets **affect the amounts of net income, retained earnings, and total assets
Effect of Judgement and Estimation
Different companies use differing allocation methods to best match their expenses with their revenues (straight line, double-declining/accelerated, units of production)
Changes in estimates
changes in estimates do not affect the amount of depreciation recognized previously; instead the remaining book value is expense over its remaining useful life
To illustrate the different depreciation methods, consider a van purchased by Dryden Enterprises. Dryden plans to use the van as rental property. The van had a list price of $23,500. Dryden obtained a 10 percent cash discount from the dealer. The van was delivered FOB shipping point, and Dryden paid an additional $250 for transportation costs. Dryden also paid $2,600 for a custom accessory package to increase the van's appeal as a rental vehicle. The cost of the van is computed as follows.
**Also note that the estimated salvage of 4,000 and an estimated useful life of four years
Revision of salvage
*assume the original life remained 8 years, but McGraw revised its estimate of salvage value to $6,000. depreciation for each remaining year is $5125
Straight-line depreciation example
*assumes the van is used evenly over it's four year life. Revenue from renting the van is assumed to be $8,000. *produces equal amounts of depreciation expense each year Study the timing differences between cash flow and net income. Dryden spent $24,000 cash to acquire the van. Over the van's life cycle, Dryden collected $36,500 [($8,000 revenue × 4 years = $32,000) plus ($4,500 from the asset disposal) = $36,500]. The $12,500 difference between the cash collected and the cash paid ($36,500 − $24,000) equals the total net income earned during the van's life cycle.
Impairment Losses for Intangible Assets with Indefinite Useful Lives
*must be tested for impairment annually (compares fair value to the the book value) *Buyer paid $70,00 of goodwill. Popularity declines, thus revenue declines. Must recognize impairment loss. Location is still valuable, thus not all of the goodwill has been lost. Goodwill remaining is determined to be $40,000. Impairment loss to recognize is $30,000 ($70,000-$40,000). Loss reduces the intangible asset (goodwill), retained earnings, and net income.
Units of production depreciation
*suppose rental demand for van depends on economic conditions; in robust economy, travel increases and demand for renting vans is high, vis versa, thus revenue fluctuates from year to year. A method of depreciation known as units of production depreciation, accomplishes this goal by basing depreciation expense on actual asset usage. -must measure asset's productive capacity, such as number of miles the van expects to be driven
Book value
-final stage in the life cycle of a tangible asset is its disposal and removal from the company's records. Book value: cost - accumulated depreciation Dryden retired the van from service on January 1, 2014, selling it for $4,500 cash. The van's book value (cost − accumulated depreciation) when it was sold was $4,000 ($24,000 cost − $20,000 accumulated depreciation), so Dryden recognized a $500 gain ($4,500 − $4,000) on the sale.
would the cash flow from operating activities be affected by depreciation in 2012?
...
Life cycle of an operational asset involves
1. acquiring funds to buy the asset 2. purchasing the asset 3. using the asset 4. retiring the asset (disposing of)
double declining balance is computed in three steps
1. determine the straight-line rate (divide one by the asset's useful life) 1/4years=25% 2. Determine the double declining balance rate (multiply the straight line rate by 2--double the rate; 25% x 2 = 50%) 3. Determine the depreciation expense (multiply the double declining balance rate by the book value of the asset at the beginning of the period)
three alternative methods for recognizing depreciation expenses..
1. straight line 2. double declining balance 3. units of production
The alternative accounting methods for depreciating, depleting, or amortizing assets includes...
1. straight-line (equal amounts of expense in each accounting period--- cost-salvage /useful life years) 2. double declining negative (proportionately larger amounts of expense in early years and smaller amounts of expense in later years of the asset's useful life---book value x 2 xstraigt-line rate) 3. units-of production methods (produces expense in direct proportion to the number of units produced during an accounting period--- cost-salvage/total estimated units of production = allocation rate x units of production in current accounting period)
What amount of accumulated depreciation would The Pizza Factory report on the December 31, 2012, balance sheet?
1940
What amount of depreciation expense would The Pizza Factory report on the 2012 income statement?
1940
The following events apply to The Pizza Factory for the 2012 fiscal year: 1. The company started when it acquired $16,000 cash from the issue of common stock. 2. Purchased a new pizza oven that cost $12,300 cash. 3. Earned $22,500 in cash revenue. 4. Paid $11,100 cash for salaries expense. 5. Paid $3,100 cash for operating expenses. 6. Adjusted the records to reflect the use of the pizza oven. The oven, purchased on January 1, 2012, has an expected useful life of five years and an estimated salvage value of $2,600. Use straight-line depreciation. The adjusting entry was made as of December 31, 2012.
6. (Cost − Salvage value) ÷ useful life = Depreciation expense per year $12,300 − $2,600 = $9,700; $9,700 ÷ 5 = $1,940 per year
Double-Declining-Balance Depreciation
8assume demand for the van is strong when it is new, but fewer people rent the van as it ages-->the van produces smaller amounts of revenue as time goes by. T Recognize more depreciation expense in the van's early years and less as it ages
Annual depreciation expense
An asset cannot be depreciated below its salvage value Table indicates the general formula for computing units of production deprecation
Regardless of the depreciation method used...
An asset cannot be depreciated below its salvage value *zero depreciation expense in order for it not to occur
Current Assets
Assets that are used relatively quickly, within a single accounting period
Revision of life
Assume McGraw revises the expected life to be 14, rather than 8 years. The machine's remaining life would be 10 more years instead of 4 more years. Salvage value remains 3,000. depreciation for each remaining year is $2350
Costs that are capitalized
Capital expenditures: substantial amounts spent to improve the quality or extend the life of an asset *accounted differently whether the cost incurred improved the quality or extended the life of the asset
Copyrights
Copyright protects writings, musical compositions, works of art, and other intellectual property for the benefit of the creator. Copyrights granted by the federal government extend for the life of the creator plus 70 years.
Revision of Estimates To illustrate, assume that McGraw Company purchased a machine on January 1, 2012, for $50,000. McGraw estimated the machine would have a useful life of 8 years and a salvage value of $3,000. Using the straight-line method, McGraw determined the annual depreciation charge as follows:
Estimated amounts such as the salvage value and the useful life of depreciable assets and uncollectible accounts expense However, at the beginning of the 5th year, accumulated depreciation on the machine is 23,500 (5875 x 4). Machine's book value is $26,500 (50,000-23,500)... what happens?
Costs that improve quality
Expenditures that improve the quality of services that the assets provide the amount is added to the historical cost of the asset. The additional cost is expensed through higher depreciation charges over the asset;s remaining useful life. Recall that the machine originally cost $50,000, had an estimated salvage of $3,000, and had a predicted life of 8 years. Recall further that accumulated depreciation at the beginning of the fifth year is $23,500 ($5,875 × 4) so the book value is $26,500 ($50,000 − $23,500). Assume McGraw makes a major expenditure of $4,000 in the machine's fifth year to improve its productive capacity. The effects on the financial statements follow.
Franchises
Franchises grant exclusive rights to sell products to perform services in certain geographic areas
Gains
Gains are like revenues in that they increase assets or decrease liabilities. Gains are unlike revenues in that gains result from peripheral transactions rather routine operating actives. 4,500 cash received on disposal is reported as a cash inflow from investing activities
Intangible Assets
Have no physical form; cannot be seen or touched They are more likely to be physical documents, rights or privileges. EX: patent with represents privileges (privilege of the patent cannot be seen or touched, thus the patent is an intangible asset)
Effect of Industry Characteristics
Industry characteristics affect financial performance measures. The table indicates that for every $1.00 invested in property, plant, and equipment, Kelly Services produced $31.91 of sales. In contrast, Cox Communications and United Airlines produced only $0.73 and $1.31, respectively, for each $1.00 they invested in operational assets. Does this mean the management of Kelly is doing a better job than the management of Cox Communications or United Airlines? Not necessarily. It means that these companies operate in different economic environments. In other words, it takes significantly more equipment to operate a cable company or an airline than it takes to operate an employment agency.
Land
Land is separate because it is not subject to depreciation or depletion--land has an infinite life
Balance Sheet Presentation
Long Term Asset Balance Sheet Plant and Equipment Land Natural Resources Intangibles Total Long-term assets
Tangible Assets
Long term assets may be tangible or intangible They have a physical presence; they can bee seen and touched; includes equipment, machinery, natural resources, and land Classified as 1. property, plant, equipment 2. natural resources 3. land
Which of the following items should be classified as long-term operational assets?
Long-term operational assets: buildings production machinery franchise patent tract of timber land computer goodwill Short-term operational assets: cash accounts receivable prepaid rent inventory
After an asset has been placed into service, companies incur further costs for maintenance, quality, improvement, and extensions of useful life.
Maintenance costs: expensed in period they are incurred Costs that improve the quality of an asset: added to the cost of the asset, increasing the book value and amount of future depreciation charges Costs that extend the useful life of an asset: subtracted from the asset's accumulated depreciation account thereby increasing the book value of the asset
Intangible assets with indefinite useful lives
May benefits so far into the future that their useful lives cannot be estimated Such as trademark of Cocacola EX: renewable franchises, trademarks, and goodwill The cost of such assets are not expensed unless the value of the assets becomes impaired
Long-term operational assets
Other assets, like equipment, or buildings that are used for extended periods of time--two or more accounting periods
Patents
Patent grants its owner an exclusive legal right to produce and sell a product with unique features US Patents have legal life span of 20 years Companies may obtain patents through purchase, lease, or internal development.
Intangible assets with identifiable useful lives
Patents and Copyrights May be obsolete or may reach the end of their legal lives. *amortization
Identify each of the following long-term operational assets as either tangible (T) or intangible(I)
Tangible: retail store building shelving for inventory gas well drilling rig 18-wheel truck timber log loader dental chair Intangible: trademark FCC license for TV station goodwill computer software
Amortization
Term used when recognizing expense for intangible assets with identifiable useful lives
Natural resources - accounting for long term operational assets
The cost of natural resources includes not only the purchase price, but also cost of exploration, geographic surveys, and estimates. Process of expensing natural resources is called depletion (units of production) Paid $4,000,000 cash to purchase a mine with estimated 16,000,000 tons of coal. (4,000,000/16,000,000 = $0.25 per ton) If 360,000 tons of coal in the first year, depletion charge is 360,000 x $0.25 per ton = $90,000 depletion charge
Expensing Intangible Assets with Identifiable Useful Lives
The costs of intangible assets with identifiable useful lives are normally expense on a straight-line basis using AMORIZATION *An intangible asset should be amortized over two possible periods 1. its legal life 2. its useful life To illustrate, assume that Flowers Industries purchased a newly granted patent for $44,000 cash. Although the patent has a legal life of 20 years, Flowers estimates that it will be useful for only 11 years. The annual amortization charge is therefore $4,000 ($44,000 ÷ 11 years). The effects on the financial statements follow.
Trademarks
Trademark is a name or symbol that identifies a company or product. Cost incurred to design, purchase, or defend a trademark are capitalized in an asset account called trademarks.
relative Fair Market Value Method
allocate the purchase price using this method A company purchased land and a building for 240,000 cash. Appraisal showed building (270,000) land was (90,000) with a total value of 360,000. Land is worth 25% (90/360,000) total value and the building is worth 75% (270/360,000)
double declining balance
an accelerated method, produces more depreciation expense in the early years of a asset's life, with a declining amount of expense in later years
Costs that are expensed
costs of routine maintenance and minor repairs are incurred to keep an asset in good working order and are expensed in the period in which they are incurred Revenue expenditures - reduce net income when incurred, accountants often call repair and maintenance costs
depreciation expense
depreciation: usage of assets, assets suffer from wear and tear and loss their value in earning revenue Depreciation Expense: the amount of asset's cost that is allocated to expense during an accounting period
depreciable cost
difference between its original cost and its salvage value Company purchased an asset for 5,000 and once depreciated sold it for 1,000 (salvage value). The depreciable cost is 4000 (5000-1000). The portion of the depreciable cost, 4,000, that represents its annual usage is recognized as depreciation expense
Salvage value
expected market value of a fully depreciated asset
Costs that extend life
expenditures, such as replacing a roof or putting an engine on an old vehicle extends the useful life of these assets. *viewed as canceling some of the depreciation previously charged to expense; still an asset exchange Impacts cash and accounts depreciable
Intangible assets 2
intangible assets provide rights, privileges, and special opportunities to businesses. Common intangible assets include trademarks, patents, copyrights, franchises, and goodwill.
Accumulated depreciation
is a contra asset accounts, where the asset reduction is reported *account increases each year, accumulating the total amount of depreciation recognized on the asset to date
Primary object of depreciation
match the cost of a long-term tangible asset with the revenues the asset is expected to generate Natural resources-depletion Intangible assets-amorization
Natural Resources
mineral deposits, oil and gas reserves, timber stands, coal mines, stone quarries are examples of natural resources Inventories; and when sold the cost of these assets are expensed as cost of goods sold
determining the cost of long term assets Historical cost concept
requires that an asset be recorded at the amount paid for it. Includes the purchase price plus any costs necessary to get the asset in the location and condition for its intended use Common cost components: buildings, land, equipment *the cot of an asset does not include payments for fines or damages
Depletion
term used to recognize expense for natural resources
Depreciation
term used to recognize expense for property, plant, and equipment
Financial statement under double declining balance depreciation
this method smooths the amount of net income reported over the asset's useful life. In early years when heavy asset use produces higher revenue, depreciation expense is also higher, and vis versa.
Goodwill
value attributable to favorable factors such as reputation, location, and superior products. EX: popularity of a restaurant Assume a buyer agrees to purchase the restaurant by paying the owner $300,000 cash and assuming the existing liabilities. In other words, the restaurant is purchased at a price of $350,000 ($300,000 cash + $50,000 assumed liabilities). Now assume that the assets of the business (tables, chairs, kitchen equipment, etc.) have a fair market value of only $280,000. Why would the buyer pay $350,000 to purchase assets with a market value of $280,000? Obviously, the buyer is purchasing more than just the assets. The buyer is purchasing the business's goodwill. The amount of the goodwill is the difference between the purchase price and the fair market value of the assets. In this case, the goodwill is $70,000 ($350,000 − $280,000). The effects of the purchase on the financial statements of the buyer follow.
Basket purchase
when a group of assets are acquired in a single transaction the total price of a basket purchase must be allocated among the assets acquired
