CHAPTER 7 ACCOUNTING

recurring costs

is not part of the costs of the equipment, we expense them as we incur them (current period)

improvement

the cost of replacing a major component of an asset usually increases future benefits, and we should capitalize it to the equipment account

service life or useful life

the estimated use the company expects to receive from the asset before disposing of it - we can measure service life in units of time or in units of activity

depreciation method

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

change in depreciation estimate

- depreciation is an estimate -if a ____ ___ ____ is required, the company changes depreciation in current and future years, but not in prior years book value, end of year 3 - new residual value = new depreciable cost / remaining service life annual depreciation in years 4 yo 7 = 4000

franchise

- subway, mcdonald's, and starbucks are three of the largest franchises - these are local outlets that pay for the exclusive right to use for the franchisor company's name - to record the cost of a franchise, the franchise records the initial fee as an intangible asset

expenditures after acquisition

- we capitalize an expenditure as an asset if it increases future benefits - we expense an expenditure if it benefits only the current period - repairs and maintenance, additions, improvements, and litigation costs

repairs and maintenance expenditures

- we expense repairs and maintenance expenditures like these in the period incurred because they maintain a given level of benefits - they are also likely to recur again in the following period - more extensive repairs that increase the future benefits of the delivery truck would be capitalized as assets (ex.) new transmission or an engine overhaul

partial- year depreciation

1,167 = 7000* (2/12) 10 of the 12 months in year land is property but it is NEVER depreciated because its service life never ends

companies acquire intangible assets in two ways

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

Starbucks example

1200 for equipment - expected to have a service life of four years 1200/4 depreciation expense (Debit 300) Accumulated Depreciation (300 credit) - contra asset account, meaning that it reduces as an asset account credit its contra account equipment (cost) - accumulated depreciation (300 * 1) = book value

return on assets (net income/ average total assets)

= profit margin (net income/ net sales) * asset turnover (net sales/ average total assets)

double declining balance method

A method of depreciation that provides periodic depreciation expense based on the declining book value of a fixed asset over its estimated life. double-declining depreciation rate = 2/ Estimated service life we multiply the rate by book value (cost-accumulated depreciation ) rather than by depreciable cost (cost-residual value) *depreciation expense in the final year is the amount necessary to reduce book value down to residual value

tangible assets

LONG TERM ASSET - assets in this category include land, land improvements, buildings, equipment, and natural resources ex.) Krispy kreme land, buildings, and equipment

activity-based method

allocate an asset's cost based on its use measure in terms of its outputs of machine also for vehicles (miles) depreciation rate = (cost-residual value (depreciable cost)/ number of units expected

amortization

allocating the cost of intangible assets to expense the expected residual value of most intangible assets is 0 most companies use straight-line amortization for intangibles

depreciation

allocation of an asset's cost to an expense over time - over its service life - an asset provides benefits (revenues) to a company in future periods - depreciation in accounting is not a valuation process. rather, - to describe that process when it applies to property, plant, and equipment - for intangible assets, the cost allocation process is called amortization

book value

also referred to as carrying value equals the original cost of the asset minus the current balance in accumulated depreciation reduce book value through depreciation while maintaining the original cost of each asset in the accounting records

declining-balance method

an accelerated depreciation method - higher in earlier years but lower in later years *however both declining- balance and straight-line will result in the same total depreciation over the asset's service life* (Asset cost - residual value) *200% = double -declining balance method since the rate is double the straight-line rate double declining balance = 40%

tax depreciation

an acceleration method serves this objective by reducing taxable income more in the earlier years of an asset's life than straight MARCs = combine declining balance methods in earlier years with straight-line in later years to allow for more advantageous tax depreciation deduction

copyright

an exclusive right of protection given by the U.S. Copyright office to the creator of a published work such as a song, film, painting, photograph, book, or computer software reproduce work for life of creator plus 70 years

material

an item is said to be ____ if it is large enough to influence a decision - the decision to capitalize versus expense can have a material impact on financial statements *companies generally expense all costs under a certain dollar amount 1000 regardless of whether future benefits are increased legal defense of intangible assets = incurring litigation costs to defend the legal right to the asset -- capitalize future (expense if defense is unsuccessful) *we capitalize (record an asset expenditures that benefit future periods - we expense items that benefit only the current period

accelerated depreciation method

assume that the asset will provide greater benefits in the earlier years of its life than in the later years - achieve a better matching of depreciation with revenues

other companies pursue a higher asset turnover

by charger lower prices - they increase sales volume, giving them more sales per dollar invested in assets

amortization expense

debit amortization expense (40,000= 800,000/20 years) and credit franchises or patents

capitalize

describes recording an expenditure as an asset -most ____ expenditures are expensed over time s the asset is used in the company operations ex.) WorldCom improperly capitalizing expenditures --> overstated assets understated expenses

impairment loss

equals book value of an asset in excess of fair value of asset record impairment of trademark as credit (decrease as asset)

return in assets ROA

equals net income/ average total assets * we measure net income over time, whereas we measure total assets at a point in time * indicates the amount of net income generated for each dollar invested in assets a higher return on assets generally indicates a more effective use of assets

patent

exclusive right to manufacture a product or to use a process - grants this right for a period of 20 years - when a firm purchases a ____, it records the patent as an intangible asset at its purchase price plus other costs such as legal and filing fees to secure the patent

if we dispose of an asset

for more than its book value, we record a gain - if we dispose an asset for less than its book value, we record a loss

higher profit margin

indicates a company generates a higher net income per dollar of sales

a higher asset turnover

indicates a company generates a higher sales volume per dollar of assets invested

trademarks

like name Apple that distinctively identifies a company, product, or service - for a period of 10 years -advertising costs can factor into the value of a trademark in a big way - the estimated value of the trademark is not recorded in the trademark account; instead only the legal, registration, and design fees are recorded

intangible assets

long term asset - include patents, trademarks, copyrights, franchises, and good will - based on a legal contract - GOOGLE'S COPYRIGHTS

intangible assets

long term asset have no physical substance - include patents trademarks, copyrights, franchises and goodwill - one of the most valuable intangible assets is their trademark or brand

gain on the sale of a depreciable asset

means the asset was sold for more than its book value - the asset received and recorded such as cash is greater than the book value of the asset that was sold and removed from the accounting records - the net increase in the book value of total assets is an accounting gain (not an economic gain)

sale

most common method to dispose of an asset

profit margin

net income/ net sales - ratio indicates the earnings per dollar of sales - asset turnover = calculated as net sales divided by average total assets = measures the sales per dollar of assets invested

impairment

occurs when the expected future cash flows (expected future benefits) generated for a long term asset fall below its book value (original cost - accumulated depreciation)

exchange

occurs when two companies trade assets - we often use cash to make up for any difference in fair value between the assets

addition

occurs when we add a new major component to an existing asset -capitalize the cost of additions if they increase adding a refrigeration unit to a delivery truck increases the capability of the truck beyond that originally anticipated`, thus increasing its future benefits

loss

occurs when we sell an asset for less than its book value -amount of loss equals the net decrease in assets - losses like expenses have a debit balance and are reported as a decrease to net income - book value (cost of asset - accumulated depreciation) - depreciation must be recored up to date of sale, retirement or exchange - otherwise the book value will be overstated and the resulting gain or loss on disposal will be in error as well

gain

occurs when we sell an asset for more than its book value - the cash received is greater than the book value of the asset sold - the amount of the gain equals the net increase in assets - have a credit balance and are reported as an increase in net income

goodwill

often is the largest and the most unique intangible asset in the balance sheet - it is recorded only when one company acquires another company -goodwill is recorded by the acquiring company for the amount that the purchase price exceeds the fair value of the acquired company's identifiable net assets - purchase price - fair value of assets acquired less: fair value of liabilities assumed fair value of identifiable net assets (26) * we will record good will only when it is part of the acquisition of another business

natural resources

oil, natural gas, timber, and even salt - we can physically use up, or deplete natural resources -___ ____ that decreases as the firm extracts oil - timber land is used up to produce materials in the construction industry, and salt is extracted from salt mines for use in cooking and melting icy roads

record a long-term asset at its cost

plus all expenditures necessary to get the asset ready for use

reporting intangible assets that are developed internally

rather than reporting these in the balance sheet, we expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs U.S. accounting rules require firms to expense all research and development costs incurred + advertising costs as we incur them

big bath

recording all loses in one year to make a bad year even worse

land

represents ___ a company is using in its operations such capitalized costs include the purchase price of ___ +closing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording fees Computation of cost of land: purchase price of land + existing building + commissions, back property taxes, title insurance, + cost of removing existing building + cost of leveling the ___ Less: salvaged materials from existing buildings = total cost of ___ (*necessary to acquire the ___, so Olive garden capitalizes them

3 ways an asset can be disposed of

sale, retirement, exchange

residual value

salvage value = the amount expects to receive from selling the asset at the end of it service life due to the difficulty in estimating a residual value, it is not uncommon to assume a residual value of zero

basket purchase

sometimes companies purchase more than one asset at the same time for one purchase price ex.) Olive Garden purchases land, building + equip togeth fo 900,000 * we allocate the total purchase price of 900,000 based on the estimated fair values of each of the individual assets estimate relative fair values

land improvements

spend additional amounts to improve the land by adding a parking lot, sidewalks, driveways, landscaping - have limited useful lives parking lots wear out land has an unlimited useful life record sep

loss signifies

that the cash received is less than the book value of the asset that was sold; there is a net decrease in the book value of total assets

equipment

the cost of ___ is the actual purchase price plus all other costs necessary to prepare the asset for use - including sales tax, shipping, delivery insurance, assembly, installation and even legal fees incurred to establish a title cost of equipment - purchase price, - sales tax - transportation - shipping insurance - installation

buildings

the cost of acquiring a ____ usually includes realtor commissions and legal fees in addition to the purchase price

straight line

this method allocates an equal amount of depreciation to each year. the implication is that the asset is used evenly over its useful life - this method is by far the simplest and most common depreciation method - we allocated an equal amount of the depreciable cost to each yr of the asset's service life asset cost - residual value (depreciable cost) / service life 1/5 each year = .20 * the asset is depreciated until its book value equals the residual value (5,000) - the residual value is never depreciated depreciable cost * depreciation rate = depreciation expense produces a higher net income than accelerated methods in the earlier years of an asset's life *companies favor straight line

activity- based

this method calculates depreciation based on the activity associated with the asset - a vehicle can be depreciated based on the miles driven, or a machine can be depreciated based on the hours used - commonly used to allocate the cost of natural resources

declining- balance

this method is an accelerated method, meaning that the more depreciation expense is taken in the earlier years than int he later years of an asset's life - also used in calculating depreciation for tax purposes

some companies pursue a higher profit margin

through product differentiation and premium pricing - they set higher selling prices, giving them more profit per dollar of sales

depreciation refers

to the allocation of the asset's original cost to an expense during the periods benefited - depreciation does not refer to the change in value or selling price

intangible assets not subject to amortization

we do not amortize intangible assets with indefinite unknown or not determinable useful lives - good will (common intangible asset with an indefinite useful life) and trademarks with indefinite life good will = difference between the purchase price of a company and the fair value of all its identifiable net assets tangible/ intangible assets - liabilities assumed management must review long-term assets for a potential write-down when events or change sin circumstances indicate the asset's recoverable amount is less than its recorded amount in the accounting records

retirement

when a long-term asset is no longer useful, but cannot be sold