Chapter 8: Accounting for long term assets

Book value can be calculated by taking an asset's acquisition costs less its...

Accumulated depreciation

Capital expenditures

Also called balance sheet expenditures, are costs of plant assets that provide benefits for longer than current period. Increase asset on balance sheet.

Salvage value

Also called residual value or scrap value, is an estimate of the asset's value at the end of its useful life (or benefit period). Amount owner expects to receive from disposing of asset at end of its useful life. If asset is expected to be traded in on a new asset, its salvage value is expected trade-in value.

Goodwill

Amount by which company's value exceeds value of its individual assets and liabilities. Implies company as a whole has certain valuable attributes not measured in assets and liabilities. Only recorded when entire company or business segment is purchased.

Natural resources

Assets that are physically consumed when used. Ex. standing timber, mineral deposits, and oil and gas fields. Assets are soon-to-be inventories of raw materials after cutting, mining, or pumping. Until conversion happens, reported as noncurrent assets under either plant assets or own categories.

Receives cash equal to the equipment's book value, no gain or loss is recorded...

Debit cash, debit accumulated depreciation - equipment, credit equipment

Receives amount that is above book value, gain is recorded. Entry is...

Debit cash, debit accumulated depreciation - equipment, credit gain on disposal of equipment, credit equipment.

Receives amount that is below book value, loss is recorded. Entry is...

Debit cash, debit loss on disposal of equipment, debit accumulated depreciation - equipment, credit equipment

Depletion expense when all units extracted are sold

Debit depletion expense - mineral deposit, credit accumulated depletion - mineral deposit.

Depletion expense (when not all units extracted are sold)

Debit depletion expense - mineral deposit, debit ore inventory, and credit accumulated depletion - mineral deposit.

Record depreciation expense and update accumulated depreciation...

Debit depreciation expense, credit accumulated depreciation - equipment.

Entry to record depreciation up to date of disposal...

Debit depreciation expense, credit accumulated depreciation- equipment

Straight-line method adjusting entry to record straight-line depreciation

Debit depreciation expense, credit accumulated depreciation. Depreciation expense is reported on income statement. Accumulated depreciation is contra asset account on balance sheet.

Assume equipment has a book value of $800 and a fair (market) value of $750, and this $50 decline in value meets impairment test. Impairment entry is...

Debit impairment loss, credit accumulated deprecation- equipment

Entry for impairment...

Debit impairment loss, credit accumulated depreciation - equipment

Entry for cash purchase of land:

Debit land, credit cash

Cost of betterment is added to machinery account with entry...

Debit machinery, credit cash

Ordinary repairs entry

Ex. cleaning, lubricating, adjusting, and repainting. Expense currently Debit repairs expense, credit cash

Betterments and extraordinary repairs

Ex. replacing main parts and major asset expansions. Expensed in the future Entry: debit plant asset, credit cash

Copyrights

Gives its owner exclusive right to publish and sell a musical, literary or artistic work during life of creator plus 70 years, although useful life of most copyrights is much shorter. Costs of copyrights are amortized over its useful life. Cost of copyright is fee. Costs of copyright are captialized (recorded in an asset account) and amortized by debiting account (Amortization Expense - copyrights).

Accelerated depreciation method

Has more depreciation in the early years and less depreciation in the later years. Many companies use accelerated depreciation in computing taxable income. Reporting higher depreciation expense in early years of asset's life reduces company's taxable income in those years and increases it in later years. Goal is to postpone tax payments.

Betterments (capital expenditure)

Improvements, expenditures that make a plant asset more efficient or productive. Often involves adding a component to an asset or replacing an old component with a better one and doesn't always increase useful life. Ex. replacing manual controls on a machine with automatic controls.

Inadequacy

Inability of a plant asset to meet its demands.

Cost

Includes all expenditures necessary to get an asset in place and ready for use. Expenditure must be normal, reasonable, and necessary in preparing it for its intended use.

Amortization of intangible assets

Intangible assets with limited useful lives require amortization. Similar to depreciation and uses shorter of the legal life or useful life of the intangible. Straight-line method is used unless stated otherwise. Recorded in a contra account, Accumulated Amortization. Acquisition cost of intangible assets is disclosed along with accumulated amortization.

The modified accelerated cost recovery system (MACRS):

Is included in the US federal income tax rules for depreciating assets.

Advantages of leasing an asset versus buying..

Little or no up-front payment is normally required (making it more affordable). Lease terms often allow exchanges to trade up on leased assets (reducing obsolescence).

Before discarding, selling, or exchanging plant asset...

Must record depreciation up to that date. Debit Depreciation expense, credit accumulated depreciation.

Asset book value/book value

Net balance sheet amount. Book value = cost - accumulated depreciation

Total asset turnover

Net sales/average total assets

Indefinite life

No legal, competitive, economic, or other factors limit intanglible asset's useful life. It is not amortized.

Depreciation

Process of allocating cost of a plant asset to expense while it is in use. Doesn't measure decline in asset's market value or its physical deterioration.

obsolescence

Process of becoming outdated and no longer used.

A change in an accounting estimate is...

Reflected in current and future years' financial statements, not in prior statements.

Depletion formula

Step 1. Depletion per unit = (cost - salvage value)/total units of capacity. Step 2. Depletion expense = depletion per unit x units extracted and sold in period

Double-declining-balance depreciation formula

Step 1. Straight-line rate = 100%/useful life. Step 2. Double-declining-balance rate = 2 x straight-line rate. Step 3. Depreciation expense = double -declining-balance rate x beginning-period book value

Trademark or trade (brand) name

Symbol, name, phrase, or jingle identified with a company, product or service. Ex. Nike swoosh. Cost of developing, maintaining, or enhancing value of trademark or trade name is charged to expense when incurred. If trademark is purchased, its cost is debited to asset account and then amortized over its expected life.

Lessee

The one who secures right to possess and use the property.

The book value of an asset when using straight-line depreciation is always greater than book value from using double-declining balance, except at beginning and end of asset's useful life, when it's the same.

True

Disposals of planet assets occur...

discarding, sale, or exchange.

Average total assets

(Current period-end total assets + prior period end total assets)/2

Accounting for disposals of planet assets

1. Record depreciation up to the date of disposal - also updates accumulated depreciation. 2. Record removal of disposed asset's account balances - including its accumulated depreciation. 3. Record any cash (and/or other assets) received or paid in the disposal. 4. Record any gain or loss - equal to value of any assets received minus the disposed asset's book value

Issues in accounting for plant assets

1. computing costs of plant assets. 2. allocating costs of plant assets. 3. accounting for subsequent expenditures to plant assets. 4. Recording disposal of plant assets

Factors determining depreciation:

1. cost 2. salvage value 3. useful life

Straight-line depreciation rate

100%/number of periods in the asset's useful life.

Computing revised straight-line depreciation

(book value - revised salvage value)/ revised remaining useful life.

Straight-line depreciation forumla

(cost - salvage value)/useful life in periods

Straight-line rate

100%/useful life

Double-declining-balance rate

200%/useful life

Land improvements

Additions to land and have limited useful lives. Ex: parking lots, driveways, walkways, fences, and lighting systems. Include cost necessary to make those improvements ready for their intended use.

Modified Accelerated Cost Recovery System

Allows straight-line depreciation for some assets, but requires accelerated depreciation for most kinds of assets. Not acceptable for financial reporting because it doesn't consider asset's useful life or salvage value. Depreciation method that allows companies to accelerate depreciation for tax purposes.

Revenue expenditures

Also called income statement expenditures, are costs that don't materially increase plant asset's life or capabilities. They are recorded as expense on current-period income statement.

Double declining balance book value

Book value = cost - accumulated depreciation

Straight-line depreciation

Charges amount to each period of the asset's useful life. Two-step process is used. Compute depreciable cost of asset, also called cost to be depreciated. It is computed as asset total cost- salvage value. Depreciable cost is divided by number of accounting periods in asset's useful life.

Units-of-production depreciation

Charges varying amount for each period depending on asset's usage. When equipment use varies from period to period, method better matches expenses with revenues.

Double-declining-balance (DDB)

Common depreciation rate is double the straight-line rate. Done in three steps: 1. compute asset's straight-line depreciation rate, 2. double straight line rate, 3. compute depreciation by multiplying this rate by asset's beginning-period book value.

Calculate cost of amortization...

Cost / estimated useful life (ex. remaining years on lease). Does not have a salvage value.

Entry to record discarding fully depreciated asset is...

Debit accumulated depreciation - machinery, credit machinery. When accumulated depreciation equals asset's cost, it is fully depreciated (zero book value).

Purchase patent with useful life of 10 years, make following adjusting entry at end of each of the 10 years to amortize one-tenth of its cost

Debit amortization expense - patents, credit accumulated amortization - patents.

Entry for lump-sum cash purchase:

Debit building, debit land, and credit cash.

Reports maintenance and repair costs are expenses are incurred. If current year repair costs are $9,500, it makes what entry.

Debit repairs expense, credit cash.

Extraordinary repairs (capital expenditure)

Expenditures that extend asset's useful life beyond its original estimate. Costs are debited to asset account.

Research and development costs

Expenditures to discover new products, new processes, or knowledge. Costs are expensed when incurred. Not intangible assets.

Ordinary repairs (revenue expenditure)

Expenditures to keep an asset in good operating condition. Don't extend an asset's useful life or increase its productivity beyond original expectations. Ex. normal costs of cleaning, lubricating, changing oil, and replacing small parts of a machine. Revenue expenditures. Costs are reported as expenses on current-period income statement.

Leasehold improvements

Lessee sometimes pays for improvements to the leased property such as partitions, painting, and storefronts. Lessee debits these costs to a Leasehold Improvements account. Amortization entry debits amortization expense - leasehold improvements, credits accumulated amortization - leasehold improvements.

Discarding partially depreciated asset...

Loss is the book value (cost - accumulated depreciation) of the asset when discarded. Debit accumulated depreciation- equipment, debit loss on disposal of equipment, and credit equipment.

Intangible assets

Nonphysical assets used in operations that give companies long-term rights or competitive advantages. Ex. patents, copyrights, licenses, leaseholds, franchises, and trademarks.

Useful life

Of a plant asset, length of time it's used in a company's operations. Or service life, might not be as long as asset's total productive life.

Lump-sum purchase/group, bulk, or basket purchase

Plant assets sometimes are purchased as a group in a single transaction for a lump-sum price. Allocate cost to the assets acquired based on their relative market (or appraised) values.

Depletion

Process of allocating cost of natural resource to the period when it's consumed. Natural resources reported on balance sheet at cost minus accumulated depletion.

Lessor

Property's owner grants the lease

Change in an accounting estimate

Revising an estimate of useful life or salvage value of a plant asset. Only affects current and future financial statements. If estimate of an asset's useful life and/or salvage value changes, we use new estimate to compute depreciation for current and future periods.

Franchises and licenses

Rights company or government grants an entity to sell a product or service under specific conditions. Costs of franchises and licenses are debited to a Franchise and Licenses asset account and are amortized over life of agreement.

Leasehold

Rights lessor grants to the lessee under terms of the lease.

Units-of-production depreciation formula

Step 1: Depreciation per unit = (cost - salvage value)/total units of production Step 2: Depreciation expense = depreciation per unit x units produced in a period

Plant assets

Tangible assets used in a company's operations that have a useful life of more than one accounting period. Also called plant and equipment; property, plant and equipment (PP&E); or fixed assets. Set apart from other assets by: used in operations and have useful lives extending over more than one accounting period. Recorded at cost when acquired.

Declining-balance method

Uses a depreciation rate that is a multiple of straight-line rate.

Purchased good will is recorded...

When an entire company or business segment is purchased. Computed as purchase price of company minus market value of net assets. Recorded as asset.

Impairment

When there is a permanent decline in fair value of asset relative to its book value, company writes down asset to this fair value.

Another name for capital expenditure is: a. revenue expenditure b. asset expenditure c. long-term expenditure d. contributed capital expenditure e. balance sheet expenditure

e. balance sheet expenditure

Which of the following isn't classified as plant assets: a. land b. land improvements c. buildings d. machinery and equipment e. patent

e. patent

Patent

exclusive right granted to its owner to manufacture and sell a patented item or to use a process for 20 years. When rights are purchased, cost to acquire rights is debited to account called Patents. If owner engages in lawsuits to successfully defend patent, cost of lawsuits is debited to Patents account. If defense is unsuccessful, book value is expensed. Costs of research and development leading to a new patent are expensed when incurred.

Limited life

intangible cost is expensed over its estimated useful life using amortization. Intangible asset is recorded at cost when purchased.

Lease (Right-of-use asset)

property is rented under a contract. Rights the lessor grants to the lessee under terms of the lease