Financial Accounting 2 Exam 2 Legal

Cost allocation for Property, plant, and equipment and intangible assets.

The acquisition cost of these assets should be allocated to periods benefited by their use

Depreciation of Equipment Used in Extraction If the asset is movable and useable on future projects

The asset's depreciable base should be allocated over its useful life

Why service life is less than physical life for tangible assets

(1) Expected rate of technological change (2) Suppliers are expected to develop new technologies that are more efficient (3) Sold in market that frequently demands new products (4) Economically not feasible (5) Management intent

investor does not have significant influence

(Typically owns less than 20% of voting stock) Reporting Method: Fair value through net income—similar to the trading-securities approach used for debt; investment reported at fair value (with unrealized holding gains and losses included in net income), unless fair value is not readily determinable

Half-year convention

- A convention where one-half of a full year's depreciation is recorded in the year of acquisition and another half in the year of disposal

examples of changes in circumstances indicating that an asset may be impaired:

- A significant decrease in market price - A significant adverse change in how the asset is being used or in its physical condition - A significant adverse change in legal factors or in the business climate - An accumulation of costs significantly higher than the amount originally expected for the acquisition or construction of an asset - A current-period loss combined with a history of losses or a projection of continuing losses associated with the asset

Straight-line (SL) method

- Allocates an equal amount of depreciable base to each year of the asset's service life

AFS: Statement of Cash Flows

- Cash flows from buying and selling AFS securities are classified as investing activities

Held to maturity statement of cash flow presentation

- Cash flows from buying and selling HTM securities are classified as investing activities

Trading Securities: Cash Flow Statement

- Cash flows from buying and selling trading securities are classified as operating activities

Accelerated methods

- Declining pattern of depreciation, with higher depreciation in the earlier years of the asset's life and lower depreciation in later years

Impairment disclosure notes

- Description of the impaired asset or asset group - The facts and circumstances leading to the impairment - The amount of the loss if not separately disclosed on the face of the income statement - The method used to determine fair value

Trading Securities: Income statement and statement of comprehensive income

- Gains and losses are included in the income statement in the periods in which fair value changes, regardless of whether they are realized or unrealized - Do not affect other comprehensive income (OCI)

AFS: Income statement and statement of comprehensive income

- Gains and losses are shown in OCI in the periods in which changes in fair value occur - Those amounts are reclassified out of OCI and recognized in net income in the periods in which securities are sold

AFS: Balance Sheet

- Investments in AFS securities are reported at fair value - Unrealized holding gains, and losses become part of AOCI in shareholders' equity, and are reclassified out of AOCI in the periods in which securities are sold

Held to Maturity Balance Sheet presentation

- Investments in HTM securities are reported at amortized cost, less any allowance for credit losses - Fair values of those investments are disclosed in the notes to financial statements

Trading Securities: Balance Sheet

- Investments in trading securities are reported at fair value, typically as current assets

When the investment is acquired in mid-year

- Only recognize the investor's share of the year's activity When the investee reports a net loss: - The investment account would be decreased by the investor's share of the investee's net loss

Asset Service Life

- Physical life will vary according to the purpose for which the asset is acquired and the environment in which it is operated Service life of an asset is less than the physical life

When to Test for Impairment of Property, Plant, and Equipment and Finite-Life Intangible Assets

- Tested for impairment only if events or changes in circumstances indicate that the book value of the asset or asset group may not be recoverable.

What does significant influence mean?

-Decisions can be swayed in the direction the investor desires accounted for by the equity method

Equity Securities Notes to financial statement

-Disclose the portion of unrealized gains and losses for the period -How carrying value was calculated when fair value is not readily determinable

Equity Securities: Balance sheet

-Short term: Current assets -Long term: Noncurrent assets

Equity Securities: Cash flow statement

-Short term: Operating activities -Long term: Investing activities

How expenditures can increase future benefits

1. An extension of the useful life of the asset 2. An increase in the operating efficiency of the asset resulting in: • Increase in the quantity of goods or services produced • Decrease in future operating costs 3. An increase in the quality of the goods or services produced by the asset

Units-of-production method

Activity based - Computes a depreciation rate per measure of activity and then multiplies this rate by actual activity n (n+1)) ÷2 for denominator

Time-based allocation method

Allocates the depreciable base according to the passage of time

Activity-based method

Allocates the depreciable base using a measure of the asset's input or output

Additions

CAPITALIZED Adding a new major component to an existing asset should be capitalized because future benefits increased - Capitalized cost includes all necessary expenditures that are required to bring the addition to a condition and location for use

Improvements

CAPITALIZED • Involves the replacement of a major component of an asset • In either case, the cost of the improvement usually increases future benefits • It should be capitalized by increasing the book value of the related asset and depreciated over the useful life of the improved asset *think of improvement as an individual account with separate depreciation*

Repairs and Maintenance

EXPENSED • Made to maintain a given level of benefits provided by the asset • Do not increase future benefits • Future benefits are not provided beyond those originally anticipated • Expenditures for these activities should be EXPENSED in the period incurred

Depreciation

For plant and equipment cost allocation

Hold to maturity financial statement presentation

Income Statement and Statement of Comprehensive Income: - Realized gains and losses are shown in net income in the period in which securities are sold - Unrealized holding gains, and losses are disclosed in notes to financial statements - Do not affect other comprehensive income (OCI)

Allocation Base

Initial value of the asset at its acquisition - residual value • Estimating residual value for many assets can be very difficult due to the uncertainty about the future • Residual values sometimes are immaterial and are assumed to be zero

Why service life is less than physical life for intangible assets

Legal or contractual life provides the upper bound for service life

Depletion

Natural resource cost allocation

Treatment of Unrealized Holding Gains and Losses Held-to-maturity

Not recognized

Interest rate > Market rate

Premium

Treatment of Unrealized Holding Gains and Losses for trading securities

Recognized in net income, and therefore in retained earnings as part of shareholders' equity.

Treatment of Unrealized Holding Gains and Losses Available-for-sale

Recognized in other comprehensive income, and therefore in accumulated other comprehensive income in shareholders' equity.

Methods used to record the cost of improvements

Substitution Capitalization of new cost Reduction of accumulated depreciation

Disclosure of securities

Trading securities, held-to-maturity securities, and available-for-sale securities are either current or noncurrent depending on when they are expected to mature or to be sold. • Investors should disclose the following in the disclosure notes for each year presented: - Aggregate fair value - Gross realized and unrealized holding gains - Gross realized and unrealized holding losses - Change in net unrealized holding gains and losses - Amortized cost basis by major security type

Interest rate < market rate

discount

amortization

intangible asset cost allocation

three factors of cost allocation

service life (Expressed in units of time or in units of activity), allocation base, allocation method

investor has significant influence

typically owns between 20% and 50% of the voting stock Equity method—investment reported at cost adjusted for investor's share of subsequent earnings and dividends of the investee

investor controls the investee

typically owns more than 50% of voting stock Reporting Method: Consolidation—the financial statements of the investor and investee are combined as if they are a single company

Allocation Method

• A method should be selected that corresponds to the pattern of benefits received from the asset's use - To determine how much cost to allocate to periods over the asset's service life • According to U.S. GAAP, the chosen method should allocate the asset's cost "as equitably as possible to the periods during which services are obtained from [its] use" • Method should produce cost allocation in a "systematic and rational manner"

Impairment of Value: Property, Plant, and Equipment and Finite-Life Intangible Assets

• According to GAAP, assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets

Change in Estimates

• Accounted for prospectively • Reflected in the financial statements of the current and future periods • A disclosure note should describe the effect of a change in estimate for the current period on: - Net income - Related per share amounts

Depletion of Natural Resources

• Allocation of costs of natural resources • Activity-based units-of-production method widely used to calculate periodic depletion - Because the usefulness of natural resources is directly related to the amount of the resources extracted • Service life is the estimated amount of natural resource to be extracted Depletion base = cost - ri depletion per unit = depletion base/ estimated extractable units

Software Development Costs

• Amortization of capitalized software development costs begins when the product is available for general release to customers The periodic amortization is the greater of: 1. The percentage of revenue method 2. straight-line method

Intangible Assets Not Subject to Amortization

• An intangible asset that is determined to have an indefinite useful life is not subject to periodic amortization - Useful life is considered indefinite if there is no foreseeable limit on the period of time over which the asset is expected to contribute to cash flows of the entity • Indefinite does not necessarily mean permanent • Intangible assets with indefinite useful lives are subject to impairment Examples: Goodwill, trademarks, and tradenames

Reduction of accumulated depreciation (cost improvements)

• Asset account is left unaltered but its related accumulated depreciation is decreased • Book value is same as in capitalization of cost method, but the cost and the accumulated depreciation amounts both differ under the two methods

Available-for-Sale Securities

• Available-for-sale (AFS) securities aren't held for trading or designated as held to maturity -The investment is available for sale -Reported in balance sheet at fair value -Unrealized holding gains, and losses are not included in net income but reported in statement of comprehensive income as other comprehensive income (OCI)

Debt Security

• Bonds • Notes -Specified date when it matures -Face amount paid to investors on maturity -In the meantime, interest paid to investors

Change in Depreciation, Amortization, or Depletion Method

• Change in accounting estimate that is achieved by a change in accounting principle • Accounted for in the same way as any other change in accounting estimate • Requires a clear justification as to why the new method is preferable - Because this change in estimate is a result of a change in accounting principle

Substitution (cost improvements)

• Disposition of the old component • Acquisition of the new component

Residual value of Intangible Assets Subject to Amortization

• Expected residual value of an intangible asset usually is zero • The residual value is not zero if at the end of the asset's useful life to the reporting entity the asset will benefit another entity

Rearrangements

• Expenditures made to restructure an asset without addition, replacement, or improvement • Objective: - Create a new capability for the asset and not necessarily extend its useful life

Dispositions

• Gain or loss recognized for the difference between the consideration received and the asset's book value Selling price less: Original Cost of sold asset less: accumulated depreciation

Measurement

• If an impairment loss is recognized, the written-down book value becomes the new cost base for future cost allocation - The amount at which the asset could be bought or sold in a current transaction between willing parties - If fair value is not determinable, it must be estimated - Fair value often is estimated as the discounted present value of future cash flows

If rearrangement expenditures are material

• If they clearly increase future benefits: - They should be capitalized and then expensed in the future periods benefited

Impairment of Value

• Implicit assumption in allocating the cost of an asset over its useful life: There has been no significant reduction in the anticipated total benefits or service potential of the asset. • Situations can arise that cause a significant decline or impairment of those benefits or service potentials

Retirements

• Instead of selling a used asset, a company may retire (or abandon) the asset At the time of retirement: • The asset account and the corresponding accumulated depreciation account is removed from the books • A loss equal to the remaining book value of the asset is recorded

Trading Securities (TS)

• Investments in debt or equity securities acquired principally for the purpose of selling them in the near term -Active buying and selling of securities -Holding period generally is measured in hours and days rather than months or years -Typically reported among the investor's current assets -Carried at fair value on the balance sheet, and -Unrealized holding gains, and losses are included in net income in the income statement

useful life for Intangible Assets Subject to Amortization

• Legal, regulatory, or contractual provisions often limit the useful life of an intangible asset • Useful life might sometimes be less than the asset's legal or contractual life

Materiality Thresholds for Capitalization

• Many companies set materiality thresholds for the capitalization of any expenditure Example: A company might decide to expense all expenditures under $1,000 regardless of whether or not future benefits are increased

Expenditures Subsequent to Acquisition

• Many long-lived assets require expenditures to repair, maintain, or improve them after their acquisition • Expenditures that produce benefits beyond the current fiscal year are capitalized (increase in net assets) • Expenditures that maintain a given level of benefits are expensed in the period they are incurred

Sum-of-the-years'-digits (SYD) method

• Multiplies depreciable base by a declining fraction

Recognizing impairment loss

• Remaining book value of the asset is written off as a loss. • Recognizing and measuring an impairment loss depends on whether the assets are: - To be held and used or - Being held for sale

Impairment of Value: Assets Held and Used

• Should be written down if there has been a significant impairment of value • A write-down can provide important information about the future cash flows that a company can generate from using the asset • Even if the significant impairment of value has occurred, it often is difficult to measure the amount of the required write-down

Depreciation of Equipment Used in Extraction If the asset is not movable

• The asset should be depreciated over its useful life or the life of the natural resource, whichever is shorter

Capitalization of new cost (cost improvements)

• The cost of the improvement is included as a debit to the related asset account • The original cost and accumulated depreciation of the original component are not removed • Acceptable only if the book value of the original component has been reduced to an immaterial amount through prior depreciation

If an intangible right is successfully defended

• The litigation costs should be capitalized and amortized over the remaining useful life of the related intangible

If an intangible right is unsuccessfully defended

• The litigation costs should be expensed immediately as incurred because they provide no future benefit • The book value of any intangible asset should be reduced to realizable value

Allocation method of Intangible Assets Subject to Amortization

• The method of amortization should reflect the pattern of use of the asset in generating benefits

If rearrangement expenditures are not material or if it's uncertain that future benefits have increased

• They should be expensed in the period incurred

Cash flows for estimates

• Undiscounted estimates of cash flows are used to determine whether an impairment loss has occurred • Discounted estimates of cash flows often are used to estimate fair value to determine the amount of the loss

Partial Period Depreciation

• When acquisition and/or disposal occurs at times other than the beginning or the end of a company's fiscal year • Depreciation, depletion, and amortization is recorded for the part of the year that the asset actually, is used