principles of accounting chapter 7

loss

"other expenses and losses" debited

gain

"other revenues or gains" credited

double declining balance rate=

(2) x straight-line rate

depreciation cost per unit=

(cost-residual value)/expected usage of the asset

to find a partial year depreciation rate

(cost-residual value)/expected useful life= X (months/12) -after the good is fully depreciated a partial depreciation needs to be recorded to fully depreciate the asset

straight-line depreciation=

(cost-residual)/expected useful life

in order to measure depreciation you need

-cost of the fixed asset -useful life or expected life of the fixed asset r-esidual value or salvage value of the fixed asset

Tax depreciation rules

-designed to stimulate investment in operating assets and therefore are not guided by the matching principle -provide for the rapid expensing of depreciable assets, which lower taxes by bringing forward the bulk of depreciation expense -enable companies to save cash by delaying payment of taxes

depreciation for partial years

-if the fixed asset is purchased at the beginning or end of an accounting period, a full year of depreciation is recorded -if the asset is purchased during the accounting period the matching principle requires that depreciation be recorded only for the portion the year that the asset was used to generate revenue

most businesses choose the straight-line method because of

-simplicity and ease -method produces a higher reported income in the early years of an asset's life -once you choose a method you must stick with it

to revise a depreciation expense the following steps are performed:

1.obtain the book value of the asset at the date of the revision of depreciation 2. compute depreciation expense using the revised amounts for book value, useful life and/ or residual value

straight line rate=

1/useful life

an impairment is

a permanent decline in the future benefit or service potential of an asset -may be due to including too little depreciation expense being recorded in previous years or obsolescence of the asset

straight-line depreciation method

allocates an equal amount of an asset's cost to depreciation expense for each year of an asset's useful life -use for those asset which an equal amount of service potential be used each period

fair value

an asset is the estimated amount of cash that would be required to acquire the asset - this cash equivalent cost can be inferred from information about similar assets in comparable transactions

it is important to know that land has

an unlimited life and service potential and is not subject to depreciation

the cost of a fixed asset is

any expenditure necessary to acquire the asset and to prepare the asset for use

the expense recognition principle

as the service potential of an operating asset declines the cost of the asset is allocated as an expense among the accounting periods in which the asset is used and benefits are received

equipment

assets used in operations machinery, furniture, automobiles

the straight-line depreciation method produces

a constant amount of depreciation expense in each period of the asset's life and is consistent with a constant rate of decline in service potential

natural resources

coal deposits, oil reserves, and mineral deposits, make up an important part of the operating assets for many companies -are physically consumed as they are used by a company. -can generally be replaced or restored only by an act of nature

expenditures after acquisition

companies must decide if repairs and maintenances are either capitalized or expensed

Modified Accelerated Cost Recovery System (MACRS)

companies use this to compute depreciation expense for their tax returns is similar to the declining balance method but is not acceptable for financial reporting purposes

depreciation is a

cost allocation process, it is not an attempt to measure the fair value of the assets value

depreciable cost

cost of the asset-residual value is the amount that will be depreciated (expensed) over the asset's useful life

depletion rate=

cost-residual value/recoverable units

organizational costs

costs such as legal fees, stock issue costs, accounting fees, and promotional -always an expense

a revision of depreciation expense is accounted for in

current and future periods

average age of fixed assets

indicates a company's capital replacement policy and assists managers in estimating future capital expenditures accumulated depreciation/depreciation expense

amortization

intangible assets

indefinite life intangibles

is not amortized but is reviewed annually for impairment

useful life

is the period of time over which the company anticipates deriving benefit from the use of the asset

companies often purchase fixed assets by

issuing debt

accounting for intangible assets

recorded at cost, consistent with the historical cost principle -similar to fixed assets, the cost of an intangible asset is any expenditure necessary to acquire the asset and to prepare the asset for use -intangible assets purchased from outside the company, the primary element of the cost is the purchase price -costs such as registration, filing, and legal fees are considered necessary costs and are capitalized as part of the intangible asset

operating assets are the

most costly of the various types of assets acquired by an entity

the declining balance method differs from the straight line method because it

multiplies depreciation rate by the book value rather than by the depreciable cost of the asset

amortization (finite life)

the cost of an intangible asset with a finite life and allocating to accounting periods over the life of the asset to reflect the decline in service potential

internally developed intangible assets

the cost of developing the asset is expense as incurred and normally recorded as research and development expense

accumulated depreciation is deducted from

the cost of the asset to get the asset's book value or carrying value -shows the disclosures relating to property, plant, and equipment and depreciation

depletion

natural resources

natural resources

naturally occurring materials that have economic value, can be timberlands and deposits such as coal, oil and gravel

fixed asset turnover ratio=

net sales/average net fixed assets -measures how efficiently a company is using its fixed assets

involuntary disposal

occurs when assets are lost or destroyed through theft, acts of nature, or by accident

voluntary disposal

occurs when the company determines that the asset is no longer useful

cost

of a fixed asset is any expenditure necessary to acquire the asset and to prepare the asset for use

the book value of an asset that is reported on a company's balance sheet is

often quite different from the market value of the asset

the asset is valued at the fair value of the liability

on the date the asset is acquired -thus interest on borrowed funds normally is not added to the purchase price of an asset

when non cash consideration, such as land or other non cash assets, is given up

or the fair value of the asset received whichever is more clearly determinable

deprecation

property, plant and equipment

fixed assets

property, plant and equipment or land, building, machines and automobiles

the expense recognition principle

provides the conceptual basis for measuring and recognizing depreciation and requires that the cost of a fixed asset be allocated as an expense among the accounting periods in which the asset is used and revenues are generated by its use

the cost of a machine would be its

purchase price, plus sales taxes, freight, installation costs, and the cost of labor materials for trial runs that check its performance

the historical cost principle requires that a company

record its fixed assets at the exchange price at the time the asset is purchased -when cash is paid in exchange for an asset, the amount of cash given plus any other expenditure necessary to prepare the asset for use becomes part of the historical cost

The Internal Revenue Code

this specifies which depreciation method a company should use to prepare tax returns

depreciable cost=

useful life

historical cost principle

when an operating asset is recorded at its cost, including the cost of acquiring the asset and the cost of preparing the asset for use

impairments

when the fair value of the asset falls significantly below the book value of the asset then the asset is impaired

capitalized expenditures

added to an asset account

R&D expense (research and development)

expenditures of R&D may lead to intangible assets but R&D itself is not an intangible asset -always an expense

revenue expenditures

expenditures that do not increase the future economic benefits of the asset -maintain the level of benefits provided by the asset, relate only to the current period, occur frequently and typically involve relatively small dollar amounts

cost of goods sold

expense related to natural resources

recurring costs that benefit a period of time, not the asset's life are

expensed instead of capitalized

capital expenditures

extend the life of the asset, expand the productive capacity, increase efficiency, or improve the quality of the product -provide benefits to the company in both current and future periods -capital expenditures are added to an asset account and are subject to depreciation -typically involve relatively large dollar amounts

impairment consistent with the principle of conservatism

if a fixed asset is impaired a company should reduce the asset's book value to its fair value in the year the impairment occurs

the disposal of PPE require two journal entries

1. an entry to record depreciation expense up to the date of disposal 2. an entry to: remove the asset's book value(cost of the asset and the related accumulated depreciation) record a gain or loss on disposal of the asset, which is computed as the difference between the proceeds from the sale and the book value of the asset

depreciation is not an attempt to

accumulate cash for the replacement of an asset, it is a cost allocation process

declining balance depreciation method

accelerated depreciation method that produces a declining amount of depreciation expense each period by multiplying the declining book value of an asset by a constant depreciation rate -result in a smaller depreciation expense later in an items life

revision of depreciation

based on estimates of useful life and residual value -as new or additional information becomes available a company will often find it necessary to revise its estimates of useful life, residual value or both

the useful life of any fixed asset reflects

both the physical capacities of the asset and the company's plans for its use

expenditures that new included as part of the cost of asset are

capitalized

the amount of depreciation expense is recorded each period by making the following adjusting journal entry

debit: depreciation expense credit: accumulated depreciation

the units-of-production depreciation method

decline in an asset's service potential is proportional to the usage of the asset and the asset usage can be measured

declining balance depreciation expense=

declining balance rate x book value

depletion=

depletion ratexunits recovery

cost-residual value=

depreciable cost

units-of-production expense=

depreciation cost per unit x actual usage of the asset

the allocation for the expense recognition principle is called

depreciation for property, plant, and equipment assets and amortization for intangible assets and depletion for natural resources

for many companies the largest periodic expense if

depreciation, amortization and depletion

depreciation expense depends on

estimates of both useful life and residual value, depreciation expense itself is an estimate

operating assets represent

future economic benefits, or service potential that will be used in the normal course of operations

economic benefits associated with intangible assets are

legal rights and privileges conferred on the owner of the asset

land improvements, buildings and equipment have

limited lives and limited service potential and thus these assets are recorded in separate accounts and depreciated over the periods in which they are used to generate revenue

operating assets

long-lived assets that are used by the company in the normal course of operations, they are not sold to customers but are used by a company in the normal course of operation

the units-of-production method is based on a

measure of the asset's use in each period -based on a pattern tailored to the individual asset and its use

capitalized

reported as long-term assets with a service potential of greater than 1 year

expensed expenditures

reported in total on the income statement

depreciation expense

reported on the income statement

intangible operating assets

represent future economic benefit to the company -patents, copyrights, trademarks, leaseholds,organization costs, franchises, and goodwill

accumulated depreciation

represents the total amount of depreciation expense that has been recorded for an asset since the asset was acquired -is reported on the balance sheet as a contra asset

intangible assets

result form legal and contractual rights, do not have physical substance, include patents copyrights, trademarks, licenses and goodwill

how does management choose a depreciation method?

should select the method that best matches the pattern of decline in service potential of the asset

land

site of a manufacturing facility or office building used in operations

land improvements

structural additions or improvements to land driveways parking lots, fences, landscaping, lighting

buildings

structures used in operations factory, office, warehouse

residual value (salvage value)

the amount of cash trade-in consideration that the company expects to receive when an asset is retired from service

the declining balance depreciation method accelerates

the assignment of an asset's cost to depreciation expense by allocating a larger amount of cost to the early years of an asset's life -is consistent with a decreasing decline in service potential and a decreasing amount of depreciation expense

as natural resource is extracted

the natural resource is reduced and the amount of depletion computed is added to inventory, as inventory is sold the company will recognize an expense (cost of goods sold)

depletion

the process of allocating the cost of the natural resource to each period in which the resource is used

depreciation

the process of allocating, in a systematic and rational manner, the cost of a tangible fixed asset to expense over the asset's useful like

depreciation methods

the service potential of a fixed asset is assumed to decline with each period of use but the pattern of decline is not the same for all assets -some assets decline at a constant rate, some decline sharply, and some depend on how much the asset is used each period