ACCT Notes Chapter 7

What are examples of tangible assets (physical substance)?

- land, land improvements, buildings, equipment, and natural resources

What does the Property, Plant, and Equipment (Tangible Assets) consist of?

- land, land improvements, buildings, equipment, and natural resources

What is the formula for profit margin?

net income/net sales

What is the double-declining depreciation rate?

2/Estimated service life

What is the most common declining-balance rate?

200%, which we refer to as the double-declining-balance method since the rate is double the straight-line rate

Q: El Tapitio purchased restaurant furniture on September 1, 2024, for $35,000. Residual value at the end of an estimated 10-year service life is expected to be $5,000. Calculate depreciation expense for 2024 and 2025, using the straight-line method and assuming a December 31 year-end.

2024 = $1,000 2025 = $3,000 Year 2024: ($35,000 - $5,000) / 10 = $3,000 x 4/12 = $1,000 Year 2025: ($35,000 - $5,000) / 10 = $3,000

Q: Leelenau's Sandwiches acquired equipment on April 1, 2024, for $15,000. The company estimates a residual value of $1,400 and a five-year service life. Calculate depreciation expense using the straight-line method for 2024 and 2025, assuming a December 31 year-end.

2024 = $2,040 2025 = $2,720 Year 2024 = ($15,000 - $1,400)/5 years x 9/12 = $2,040 Year 2025 = ($15,000 - $1,400)/5 years = $2,720

Ex: Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Cost of the new truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years or 100,000 miles What is the activity-based depreciation rate?

$40,000 - $5,000 / 100,000 expected miles = $0.35 per mile

Ex: Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Cost of the new truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years or 100,000 miles What is the Depreciation expense for straight-line depreciation?

$40,000 - $5,000 / 5 years = $7,000 per year

Q: A company makes a basket purchase of land, buildings, and equipment with estimated fair values of $70,000, $150,000, and $30,000, respectively. The purchase price is $210,000. How much should be recorded to the Land account? - $126,000 - $70,000 - $58,800 - $25,200

$58,800 - Explanation: Purchase price = $210,000. The total estimated fair value of the three assets equals $250,000. Land's relative fair value is 28% (or $70,000 / $250,000). Therefore, the land would be recorded for $58,000 (or $210,000 x 28%).

Q: How much depreciation should be recorded for the first year for a delivery truck with a cost of $30,000, an expected life of six years, and an estimated residual value of $6,000? Assume the double-declining-balance method is used. - $12,000 - $10,000 - $8,000 - $5,000

- $10,000 Explanation: The straight-line rate for a six-year asset is ⅙. This rate would be doubled to 2/6 (or 33.33%). Depreciation the first year (rounded): $10,000 = $30,000 x 33.33%

Q: Jacobi Landscaping sold lawn equipment for $7,000. The equipment was originally purchased for $20,000, and depreciation through the date of sale totaled $15,000. What is the amount of the gain (or loss) on the sale? - $13,000 - $8,000 - $(2,000) - $2,000

- $2,000 Explanation: Sale amount = $7,000; Cost of equipment = $20,000; Less: Accum. Depreciation = ($15,000); Book value = $5,000; Gain on sale = $2,000

Q: How much depreciation should be recorded in the first year for a delivery truck purchased on April 1 with a cost of $30,000, an expected service life of five years, and an estimated residual value of $5,000? Assume the straight-line method is used - $5,000 - $3,750 - $4,500 - $6,000

- $3,750 Explanation: Annual depreciation would be: $5,000 = ($30,000 - $5,000) / 5 years. Therefore, depreciation from April 1 through December 31 (9 months) in the first year would be: $3,750 = $5,000 x 9/12

Ex: In early January, Little King Sandwiches acquired from University Hero two tangible assets - franchise and patent. The details of the transaction include: - Purchase price of the franchise is $800,000, and the agreement is for a period of 20 years - Purchase price of the patent is $72,000. The original legal life of the patent was 20 years, and there are 12 years remaining. However, due to expected technological obsolescence, the Little King estimated that the useful life of the patent is only 8 more years. (9 years total). Little King uses straight-line amortization for all intangible assets. The company's fiscal year-end is December 31... Little King records the amortization expense for the franchise and the patent as....

1. Debit: Amortization Expense ($40,000) Credit Franchises ($40,000) - ($40,000 = $800,000/20 years) 2. Debit: Amortization Expense ($9,000) Credit: Patents ($9,000) - ($9,000 = $72,000/8 years)

1. Repairs and maintenance = current 2. Repairs and maintenance = future 3. Additions = Future 4. Improvements = Future 5. Legal defense of intangible assets = Future What is the usual accounting treatment for all of these?

1. Expense 2. Capitalize 3. Capitalize 4. Capitalize 5. Capitalize (Expense if defense is unsuccessful)

Distinguish gain vs loss on a sale on an asset.

1. Gain on the sale of a depreciable asset simply means the asset was sold for more than its book value 2. Loss signifies that the cash received is less than the book value of the asset that was sold

What are two characteristics of goodwill?

1. Goodwill often is the largest (and the most unique) intangible asset in the balance sheet 2. It is recorded only when one company acquires another company

- allocates a higher depreciation in the earlier years of the asset's life and lower depreciation in later years

Accelerated depreciation method

- a contra asset account representing the total depreciation taken to date

Accumulated Depreciation

- allocates an asset's cost based on its use

Activity-based method

- allocating the cost of intangible assets to expense

Amortization

Q: In early January, Burger Mania acquired 100% of the common stock of the Crispy Taco restaurant chain. The purchase price allocation included the following items: $6 million, patent; $4 million, trademark considered to have an indefinite useful life; and $6 million, goodwill. Burger Mania's policy is to amortize intangible assets with finite useful lives using the straight-line method, no residual value, and a five-year service life. What is the total amount of amortization expense that would appear in Burger Mania's income statement for the first year ended December 31 related to these items?

Amortization expense = $6,000,000 / 5 years = $1,200,000 per year (The $4 million trademark and the $6 million goodwill are not amortized, because they have indefinite service lives)

- provides a table format detailing the cash payment each period, the portions of each cash payment that represents interest and the change in carrying value, and balance of the carrying value

Amortization schedule

When a firm purchases a patent, it records the patent as what?

An intangible asset at its purchase price plus other costs such as legal and filing fees to secure the patent.

Assume Olive Garden purchases land, building, and equipment together for $900,000. Need to record land, building, and equipment in separate accounts. How much should we record in the separate accounts for land, building, and equipment?

We allocate the total purchase price of $900,000 based on the estimated fair values of each of the individual assets. (Fair value of an asset is its estimated stand-alone selling price)

What is the general rule for recording all such long-term assets?

We record a long-term asset at its cost plus all expenditures necessary to get the asset ready for use

You can determine partial year depreciation for any month. If an asset is purchased at the beginning of April (nine months until the year end), what will its first and final year of annual depreciation be multiplied by?

Year 1 = multiplied by 9/12 Final year = multiplied by 3/12

- local outlets that pay for the exclusive right to use the franchisor company's name and to sell its products within a specified geographical area

Franchises

- occurs when we sell an asset for more than its book value

Gain

We record depreciation for land improvements, buildings, and equipment, but we don't record depreciation for what?

land (not "used up" over time)

To maximize profitability, a company ideally strives to increase both....

net income per dollar of sales (profit margin) and sales per dollar of assets invested (asset turnover)

What is the formula for asset turnover?

net sales/average total assets

- occurs when a new major component is added to an existing asset

Addition

Mainline Produce Corporation acquired all the outstanding common stock of Iceberg Lettuce Corporation for $39,000,000 in cash. The book values and fair values of Iceberg's assets and liabilities were as follows: Current assets: $14,000,000 (BV) and $17,000,000 (FV) Property, plant, and equipment: $28,200,000 (BV) and $34,200,000 (FV) Other assets: $4,800,000 (BV) and $5,800,000 (FV) Current liabilities: $9,200,000 (BV) and $9,200,000 Long-term liabilities: $14,800,000 (BV) and $13,800,000 (FV) Calculate the amount paid for goodwill.

- $5 million Purchase price = $39 Less: Fair value of assets acquired = $57 Less: Fair value of liabilities assumed = (23) Fair value of identifiable net assets = 34 Goodwill = $5 million

Ex: How would you record a $10 stapler that has a 20-year service life?

- Expense Not practical to capitalize such a small amount. Companies generally expense all costs under a certain dollar amount, say $1,000, regardless of whether future benefits are increased.

What intangible assets are not subject to amortization (those with indefinite useful life)?

- Goodwill - Trademarks (with indefinite life)

What intangible assets are subject to amortization (those with finite useful life)?

- Patents - Copyrights - Trademarks (with finite life) - Franchises

What are examples of intangible assets (lack of physical substance, existence often based on legal contract)?

- Patents, Trademarks, Copyrights, Franchises, Goodwill

What are the three different ways an asset can be disposed of?

- Sale - Retirement (no longer useful but cannot be sold) - Exchange (two companies trade assets)

What does the amount of gain equal to?

- amount of the gain equals the net increase in assets - Gains, like revenues, have a credit balance and are reported as an increase to net income

What does the amount of loss equal to?

- amount of the loss equals the net decrease in assets - Losses, like expenses, have a debit balance and are reported as a decrease to net income

If a firm constructs a building rather than purchasing it, the cost of construction includes what?

- architect fees, material costs, and construction labor, manager supervision, overhead (costs indirectly related to the construction), and interest costs incurred during construction

What are the aspects of the sale of long-term assets?

- involves a transaction in which cash is received for the asset given up - the difference between the cash received and the book value of the asset given up is reported as a gain or loss in the income statement

The cost of equipment is the actual purchase price plus all other costs necessary to prepare the asset for use. What does preparing include?

- sales tax, shipping, delivery insurance, assembly, installation, testing, and even legal fees incurred to establish title

The cost of equipment is what?

- the actual purchase price plus all other costs necessary to prepare the asset for use

Do we capitalize or expense improvement?

- the cost of the improvement usually increases future benefits, and we should capitalize it to the Equipment account

No matter what allocation method we use for depreciation, what is true?

- total depreciation over the asset's service life will be equal to the depreciable cost (asset cost minus residual value) (asset is depreciated until its book value equals the residual value)

When an expenditure is not material, how is the item typically recorded?

- typically recorded as an expense regardless of its expected period of benefit

When do we use depreciation vs. amortization?

- use the term depreciation to describe that process when it applies to property, plant, and equipment (tangible) - for intangible assets, the cost allocation process is called amortization

What depreciation method do companies use for financial reporting and income tax purposes?

1. Most companies use the straight-line method for financial reporting 2. Internet Revenue Service's prescribed accelerated method (called MACRS^2) for income tax purposes (Companies record higher net income using straight-line depreciation and lower taxable income using MACRS depreciation) (MACRS combines declining-balance methods in earlier years with straight-line in later years to allow for a more advantageous tax depreciation deduction)

Suppose a company obtains two patents during the year. Patent #1 was purchased from another company for $200,000, while Patent #2 was developed internally at a cost of $200,000 (cost of salaries, supplies, equipment, and facilities). Both patents had legal and filing fees of $40,000 and $5,000, respectively. While these two situations may seem similar, what is the difference?

1. Patent #1 will result in an intangible asset being recorded for $245,000, while only the legal and filing fees would be recorded as an intangible asset for Patent #2 Patent (intangible asset) = $245,000 (Patent 1) and $45,000 (Patent 2) Research and development expenses = $200,000

Are Research and Development and Advertising reported as an intangible asset in the balance sheet?

1. Research and Development = expensed directly in the income statement 2. Advertising = reported as expenses in the income statement in the period incurred

Recording depreciation requires accountants to establish three factors at the time the asset is put into use, what are they?

1. Service life 2. Residual value 3. Depreciation method

Companies acquire intangible assets in two ways? How is that?

1. They purchase intangible assets like patents, copyrights, trademarks, or franchise rights from other companies 2. They develop intangible assets internally, for instance by developing a new product or process and obtaining a protective patent

When do we capitalize an expenditure? When do we expense an expenditure?

1. We capitalize an expenditure as an asset if it increases future benefits 2. We expense an expenditure if it benefits only the current period

What are two unusual features of declining-balance depreciation?

1. We multiply the rate by book value (cost minus accumulated depreciation), rather than by the depreciable cost (cost minus residual value) 2. In year 5, we are not able to record depreciation expense for the entire $5,184 times 0.40, because doing so would cause the book value to fall below the expected residual value. Instead, depreciation expense in the final year is the amount that reduces book value to the estimated residual value (book value beginning of year, $5,184, minus estimated residual value, $5,000 = $184)

How do we record purchase and develop intangible assets?

1. We record purchased intangible assets at their original cost plus all other costs, such as legal fees, necessary to get the asset ready for use 2. Rather than reporting developed intangible assets in the balance sheet as intangible assets, we expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs

Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Using the activity-based depreciation, the delivery truck is driven exactly 100,000 miles over the five years. What if we drive the delivery truck less than 100,000 miles by the end of the fifth year? More than?

1. We will continue to depreciate the truck past five years until we reach 100,000 miles 2. If we drive the delivery truck more than 100,000 miles by the end of the fifth year, we will stop depreciating the truck at 100,000 miles before the five years are up.

What are the three most common depreciation methods?

1. straight-line 2. Declining-balance 3. Activity-based

Q: Papa's Pizza has the following items for the past year: Net sales are $24,128, net income is $2,223, total assets at the beginning of year are $14,898, and total assets at the end of year are $15,465. What is the profit margin? - 9.2% - 61.7% - 14.6% - 14.9%

9.2%

Q: The balance sheet of Northern Sky Resort reports total assets of $710,000 and $860,000 at the beginning and end of the year, respectively. The return on assets for the year is 22%. Calculate Northern Sky's net income for the year.

= $172,700 Net income / ($710,000 + $860,000) / 2 = 22% Net income / $785,000 = 22% 22% x $785,000 = $172,700

Q: On January 1, Save More Groceries purchased store equipment for $43,000. Save More estimates that at the end of its 10-year service life, the equipment will be worth $4,000. During the 10-year period, the company expects to use the equipment for a total of 13,000 hours. Save More used the equipment for 1,200 hours the first year. Calculate depreciation expense of the equipment for the first year, using the activity-based method.

= $3,600 Depreciation rate = ($43,000 - $4,000)/13,000 hours = $3.00 per hour Depreciation expense = $3.00 per hour x 1,200 hours = $3,600

Q: On January 1, Save More Groceries purchased store equipment for $43,000. Save More estimates that at the end of its 10-year service life, the equipment will be worth $4,000. During the 10-year period, the company expects to use the equipment for a total of 13,000 hours. Save More used the equipment for 1,200 hours the first year. Calculate depreciation expense of the equipment for the first year, using the straight-line method.

= $3,9000 Depreciation expense = ($43,000 - $4,000)/ 10 years = $3,900

Q: On January 1, Save More Groceries purchased store equipment for $43,000. Save More estimates that at the end of its 10-year service life, the equipment will be worth $4,000. During the 10-year period, the company expects to use the equipment for a total of 13,000 hours. Save More used the equipment for 1,200 hours the first year. Calculate the depreciation expense of the equipment for the first year, using the double-declining-balance method.

= $8,600 Depreciation expense = $43,000 x 2/10 = $8,600

- net sales divided by average total assets, which measures the sales per dollar of assets invested

Asset turnover

- purchase of more than one asset at the same time for one purchase price

Basket Purchase

- an asset's original cost less accumulated depreciation

Book value

Depreciation is an estimate. If a change in estimate is required, the company changes depreciation in current and future years, but not in prior periods. Ex: assume that after three years Little King Sandwiches estimates the remaining service life of the delivery truck to be four more years, for a total service life of seven years rather than the original five. At this time, Little King also changes the estimated residual value to $3,000 from the original estimate of $5,000. How much should Little King report each year for depreciation in years 4 to 7? Book value, end of year 3 = $19,000

Book value ($19,000) - new residual value ($3,000) = 16,000 16,000 / new remaining service life (4) = $4,000 Annual depreciation in years 4 to 7 = $4,000 (company does not go back and change the calculations for depreciation already reported during the first three years)

- record an expenditure as an asset

Capitalize

- using the guideline of cost plus all expenditures necessary to get the asset ready for use

Computation of the Capitalized Cost of Land

- an exclusive right of protection given to the creator of a published work such as a song, film, painting, photograph, book, or computer software

Copyright

Ex: Assume that Allied Foods acquires Ritz Produce by paying $36 million in cash. The fair values of Ritz Produce's identifiable assets and liabilities are as follows ($ in millions): Accounts receivable = $10 Equipment = $32 Patent = $8 Total fair value of assets = $50 Accounts Payable = $9 Long-term notes payable = $15 Total fair values of liabilities = $24 Ritz produce net assets = $26 million (50 - 24) Why is Allied Foods willing to pay $36 million to acquire a company that has identifiable net assets of only $26 million? Allied Foods must believe that there are other benefits worth $10 million in the acquisition, but these benefits are not identified as assets in the balance sheet of Ritz Produce. Allied Food will record these unidentified assets as goodwill at the time it pays $36 million. How would we record this transaction for Allied Foods?

Debit: Accounts Receivable (10); Equipment (32); Patent (8); Goodwill (remaining purchase price) (10) Credit: Accounts Payable (9); Notes Payable (15); Cash (36)

Ex: Now assume that Little King retires the delivery truck instead of selling it. If, for example, the truck is totaled in an accident at the end of year 3, we have a $19,000 loss on retirement. Sale amount = $0 Less: Original cost of the truck = $40,000 Less: Accumulated depreciation (3 years x $7,000/year) = (21,000) Book value at the end of year 3 = 19,000 Loss = $(19,000) We record the loss on retirement as ...

Debit: Accumulated Depreciation ($21,000) and Loss: ($19,000) Credit: Equipment ($40,000)

Q: Freeman Landscaping purchased a tractor at a cost of $29,000 and sold it three years later for $15,700. Freeman recorded depreciation using the straight-line method, a five-year service life, and a $4,000 residual value. Tractors are included in the Equipment account. Assume the tractor was sold for $10,300 instead of $15,700. Record the sale.

Debit: Cash ($10,300) and Accumulated Depreciation ($15,000) and Loss ($3,700) Credit: Equipment ($29,000) Accumulated Depreciation: ($29,000 - $4,000)/5 = $5,000 per year x 3 years = $15,000

Q: Freeman Landscaping purchased a tractor at a cost of $29,000 and sold it three years later for $15,700. Freeman recorded depreciation using the straight-line method, a five-year service life, and a $4,000 residual value. Tractors are included in the Equipment account. Record the sale.

Debit: Cash ($15,700) and Accumulated Depreciation ($15,000) Credit: Gain ($1,700) and Equipment ($29,000) Accumulated Depreciation: ($29,000 - $4,000)/5 = $5,000 per year x 3 years = $15,000

Ex: Let's return to our delivery truck example for Little King Sandwiches. Assume Little King uses straight-line depreciation and records the delivery truck in the Equipment account Original cost of the truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years Depreciation/year = $7,000 If we assume that Little King sells the delivery truck at the end of year 3 for only $17,000 instead of $22,000, we have a $2,000 loss. Sale amount is less than the truck's book value. Sale amount = $17,000 Less: Original cost of the truck = $40,000 Less: Accumulated depreciation (3 years x $7,000/year) = (21,000) Book value at the end of year 3 = 19,000 Loss = $(2,000) How do we record the loss on sale?

Debit: Cash ($17,000) and Accumulated Depreciation ($21,000) and Loss (2,000) Credit: Equipment ($40,000)

Ex: Let's return to our delivery truck example for Little King Sandwiches. Assume Little King uses straight-line depreciation and records the delivery truck in the Equipment account Original cost of the truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years Depreciation/year = $7,000 If we assume that Little King sells the delivery truck at the end of year 3 for $22,000, we can calculate the gain as $3,000. The gain is equal to the cash received of $22,000 less the truck's book value of $19,000. Sale amount = $22,000 Less: Original cost of the truck = $40,000 Less: Accumulated depreciation (3 years x $7,000/year) = (21,000) Book value at the end of year 3 = $19,000 Gain = $3,000 How do we record this sale?

Debit: Cash ($22,000) and Accumulated Depreciation ($21,000) Credit: Equipment ($40,000) and Gain ($3,000) (We record the sale by removing the delivery truck accounts (both Equipment and Accumulated Depreciation) from the accounting records and recording the cash collected. The gain is the difference between the sale amount and the book value of the truck)

Ex: Let's assume the local Starbucks pays $1,200 for equipment - say, an espresso machine. The machine is expected to have a service life of our years. What is the journal entry for depreciation?

Debit: Depreciation Expense ($300) Credit: Accumulated Depreciation ($300) - (300 = 1200 / 4) (We credit equipment's contra account, which we offset against the Equipment account in the balance sheet)

Q: Holland Flour Mills purchased new equipment and made the following expenditures: Purchase price = $63,000 Sales tax = $5,400 Shipment of equipment = $880 Insurance on the equipment for the first year = $580 Installation of equipment = $1,760 Record the expenditures. All expenditures were paid in cash.

Debit: Equipment ($71,040) and Prepaid Insurance ($580) Credit: Cash ($71,620) - Each expenditure is added together with the exception of the $580 annual insurance - Holland will initially report the $580 insurance amount as prepaid insurance and expense it over the first year of coverage

Ex: Now assume that Little King exchanges the delivery truck at the end of year 3 for a new truck valued at $45,000. The dealership gives Little King a trade-in allowance of $23,000 on the exchange, with the remaining $22,000 paid in cash. We have a $4,000 gain. Trade-in allowance = $23,000 Less: Original cost of the truck = $40,000 Less: Accumulated depreciation (3 years x $7,000/year) = (21,000) Book value at the end of year 3 = 19,000 Gain = $4,000 We record the gain on exchange as ...

Debit: Equipment (new) ($45,000) and Accumulated Depreciation (old) ($21,000) Credit: Equipment (old) ($40,000) and Cash ($22,000) and Gain ($4,000)

- an accelerated depreciation method that records more depreciation in earlier years and less depreciation in later years

Declining-balance method

What is the formula for activity-based depreciation rate per unit?

Depreciable cost / Total units expected to be produced

- allocating the cost of a long-term asset to an expense over its service life

Depreciation

What is the formula for Straight-line depreciation expense?

Depreciation expense = Asset's cost - Residual value / Service life

- the pattern in which the asset's depreciable cost (original cost minus residual value) is allocated over time

Depreciation method

Ex: Disney had net income of $11,584 million and Netflix had net income of $1,867 million. Since Disney's net income is so much larger, is Disney more profitable? Not necessarily. Disney is also a much larger company as indicated by total assets. Disney's ending total assets were $193,984 million compared to $33,976 billion for Netflix. A more comparable measure of profitability than net income is return on assets. Record the return on assets for Disney and Netflix.

Disney = $11,584 / ($98,598 + $193,984)/2 = 7.9% Netflix = $1,867 / ($25,974 + $33,976)/2 = 6.2% - Disney is more profitable than Netflix

If Disney's net sales is $69,570 and the average total assets = ($98,598 + $193,984)/2. If Netflix net sales is $20,156 and the average total assets = ($25,974 + $33,976)/2. What is the asset turnover ratio for both?

Disney = 0.48 times Netflix = 0.67 times - Netflix has the higher asset turnover

If the net income for Disney is $11,584 and the net sales is $69,570, and the net income for Netflix is $1,867 and the net sales is $20,156, what is the profit margin for both?

Disney = 16.7% Netflix = 9.3% - Indicates that Disney's profit margin is higher than Netflix's

Ex: Let's assume the local Starbucks pays $1,200 for equipment - say, an espresso machine. The machine is expected to have a service life of four years. Most companies have separate accumulated depreciation accounts for each specific asset or asset class. For simplicity, we use one general account called Accumulated Depreciation. The name of the account comes from the fact that the depreciation we record each period accumulates in the account. After one year, for instance, we have....

Equipment (cost) = $1,200 Less: Accumulated depreciation ($300 x 1 year) = (300) = Book Value = $900

Ex: Let's assume the local Starbucks pays $1,200 for equipment - say, an espresso machine. The machine is expected to have a service life of four years. Most companies have separate accumulated depreciation accounts for each specific asset or asset class. For simplicity, we use one general account called Accumulated Depreciation. The name of the account comes from the fact that the depreciation we record each period accumulates in the account. After two years, for instance, we have....

Equipment (cost) = $1,200 Less: Accumulated depreciation ($300 x 2 years) = (600) = Book value = $600

What is the difficulty of the estimated fair values?

Estimated fair values of the individual assets often exceed the total purchase price.

- record the full expenditure as an expense immediately

Expense

For repairs and maintenance, the cost of an engine tune-up, oil change, or repair of a minor engine part for a delivery truck allows the truck to continue its productive activity in the current period. Capitalize or expense?

Expense

- equals the purchase price less the fair value of the net assets acquired

Goodwill

When should we capitalize the cost of additions?

If they increase, rather than maintain, the future benefits from the expenditure. - Ex: adding a refrigeration unit to a delivery truck increases the capability of the truck beyond that originally anticipated, thus increasing its future benefits

- the cost of replacing a major component of an asset

Improvement

- long-term assets that lack physical substance, and whose existence is often based on a legal contract

Intangible assets

The question to ask yourself when deciding whether to add a cost to the asset account or record it as an expense of the current period?

Is this a cost of acquiring the asset and getting it ready for use, or is it a recurring cost that benefits the company in the current period?

What is the formula for the return on assets?

Net income / average total assets

Assume Olive Garden purchases land, building, and equipment together for $900,000. Let's say the estimated fair values of the land, building and equipment are $200,000, $700,000, and $100,000 = 1 million. In that case, Olive Garden's total purchase of $900,000 will be allocated to the separate accounts for Land, Building, and Equipment based on their relative fair values. How would that happen?

Land = $200,000/$1,000,000 = 20% x $900,000 = $180,000 Building = $700,000/$1,000,000 = 70% x $900,000 = 630,000 Equipment = $100,000/$1,000,000 = 10% x $900,000 = $90,000 180,000 + 630,000 + 90,000 = 900,000

- improvements to land such as paving, lighting, and landscaping that, unlike land itself, are subject to depreciation

Land Improvements - we report land improvements separately from the land itself

- occurs when we sell an asset for less than its book value

Loss

Does this mean that goodwill and other intangible assets with indefinite useful lives will remain on a company's balance sheet at their original cost forever? Probably not.

Management must review long-term assets for a potential write-down when events or changes in circumstances indicate the asset's "recoverable amount" is less than its "recorded amount" in the accounting records

Most companies use straight-line amortization for intangibles. What does this mean?

Many companies credit amortization to the intangible asset account itself rather than to accumulated amortization.

- large enough to influence a decision

Material

For repairs and maintenance, a new transmission or an engine overhaul. Capitalize or expense?

More extensive repairs that increase the future benefits of the delivery truck would be capitalized as assets.

- assets like oil, natural gas, and timber that we can physically use up or deplete

Natural Resources

How will the capitalize expenditure be expensed?

Over time as the asset is used in company operations.

- an exclusive right to manufacture a product or to use a process

Patent

Q: Which of the following is an exclusive right to manufacture a product or to use a process? - Trademark - Patent - Copyright - Goodwill

Patent

Q: Which of the following costs would be expensed? - Adding a refrigeration - Adding a new suspension system to a delivery truck that will allow for heavier loads - Adding a new transmission to a delivery truck, which will increase its life and future benefits - Performing a tune-up on a delivery truck

Performing a tune-up on a delivery truck - Explanation: Tune-ups are necessary to maintain the truck and are regularly required. The cost of a tune-up should be expensed. All of the other items benefit future periods and should be capitalized.

- net income divided by net sales; indicates the earnings per dollar of sales

Profit margin

Q: Whole Grain Bakery purchases an industrial bread machine for $27,000. In addition to the purchase price, the company makes the following expenditures: freight, $1,700; installation, $3,400; testing, $1,200; and property tax on the machine for the first year, $540. What is the initial cost of the bread machine?

Purchase price = $27,000 Freight = $1,700 Installation = $3,400 Testing = $1,200 Total cost of the bread machine = $33,300 Explanation = the $540 property tax is a recurring cost that benefits the company in the current year. The Whole Grain Bakery will report the $540 as property tax expense in the current year.

What about recurring costs related to equipment, such as annual property insurance and annual property taxes on vehicles?

Rather than including recurring costs as part of the cost of the equipment, we expense them as we incur them

The cost of acquiring a building usually includes what?

Realtor commissions and legal fees in addition to the purchase price

- expenses that maintain a given level of benefits in the period incurred

Repairs and Maintenance

- the amount the company expects to receive from selling the asset at the end of its service life (salvage value)

Residual value - not uncommon to assume a residual value of zero

- the estimated use the company expects to receive from the asset before disposing of it (useful life)

Service life (Ex: the estimated service life of a delivery truck might be either 5 years or 100,000 miles)

- a word, slogan, or symbol that distinctively identifies a company, product, or service (Ex: Apple)

Trademark

Ex: Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Cost of the new truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years or 100,000 miles Provide a depreciation schedule using the straight-line method.

Start = $40,000 Year 1: Depreciation Expense ($7,000); Accumulated Depreciation ($7,000); Book Value ($33,000) Year 2: Depreciation Expense ($7,000); Accumulated Depreciation ($14,000); Book Value ($26,000) Year 3: Depreciation Expense ($7,000); Accumulated Depreciation ($21,000); Book Value ($19,000) Year 4: Depreciation Expense ($7,000); Accumulated Depreciation ($28,000); Book Value ($12,000) Year 5: Depreciation Expense ($7,000); Accumulated Depreciation ($35,000); Book Value ($5,000) - asset is depreciated until its book value = the residual value ($5,000)

Ex: Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Cost of the new truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years or 100,000 miles Depreciation Rate = 0.35 Year 1: 30,000 Miles Driven Year 2: 22,000 Miles Driven Year 3: 15,000 Miles Driven Year 4: 20,000 Miles Driven Year 5: 13,000 Miles Driven What is the activity-based depreciation schedule?

Starting = $40,000 Year 1: Depreciation Expense ($10,500); Accumulated Depreciation ($10,500); Book Value ($29,500) Year 2: Depreciation Expense ($7,700); Accumulated Depreciation ($18,200); Book Value ($21,800) Year 3: Depreciation Expense ($5,250); Accumulated Depreciation ($23,450); Book Value ($16,550) Year 4: Depreciation Expense ($7,000); Accumulated Depreciation (30,450); Book Value ($9,550) Year 5: Depreciation Expense ($4,550); Accumulated Depreciation ($35,000); Book Value ($5,000)

- allocates an equal amount of depreciation to each year of the asset's service life (the asset is used evenly over its service life)

Straight-line

Q: If the service life had been four years instead of five, what depreciation rates would we use under straight-line and under double-declining-balance?

Straight-line = 1/4 = 0.25 Double-declining-balance rate = 2/4 = 0.50

Q: Which of the following intangible assets would not be subject to amortization? - Patent - Trademark with an indefinite life - Copyright - Franchise

Trademark with an indefinite life

We capitalize to land all expenditures necessary to get the land ready for its intended use. Such capitalized costs include what?

The purchase price of the land plus costing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording fees (If the property is subject to back taxes or other obligations, we include these amounts as well) (Any additional expenditure such as clearing, filling, and leveling the land, or even removing existing buildings to prepare the land for its intended use, become part of the land's capitalized cost) - if we receive any cash from salvaged building materials, we reduce the cost of land by that amount

Ex: Little King Sandwiches, a local submarine sandwich restaurant, purchased a new delivery truck. Cost of the new truck = $40,000 Estimated residual value = $5,000 Estimated service life = 5 years or 100,000 miles What if the company bought the truck partially through Year 1? Little King bought the truck on November 1 and it's year-end is December 31, depreciation in Year 1 is calculated for only two of the 12 months. How would we depreciate the truck?

Year 1: Depreciation Expense = $7,000 x (2/12) = $1,167 Year 2-5: Depreciation Expense = $7,000 Year 6: Depreciation Expense = $7,000 x (10/12) = $5,833 - we depreciate the truck in Year 1 for only 2/12 of the full-year amount because we've used the truck for only 2 months of year 1 - The truck's five-year service life will extend to Year 6. Since the company depreciated the truck for only two months in Year 1, the final 10 months of depreciation will occur in Year 6 (= 10/12).

What is the expected residual value of most intangible assets?

Zero