Chapter 7 Operating Assets

Straight-line depreciation

(cost - residual value) / Expected useful life

Depreciation cost per unit

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

Declining balance rate

(m) X straight-line rate (which is 1 / useful life)

Straight-line rate

1 / useful life

The disposal of property, plant, and equipment requires 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 (the 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.

Amortization for intangible assets

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 (the expense recognition, or matching, principle).

Depletion for natural resources

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 (the expense recognition, or matching, principle).

Depreciation for property, plant, and equipment

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 (the expense recognition, or matching, principle).

Operating assets are divided into three categories:

Property, plant, and equipment (PP&E), intangible assets, and natural resources.

The historical cost principle requires that

a company records its fixed assets at the exchange price at the time the asset is purchased.

Average age of fixed assets =

accumulated depreciation / depreciation expense

Book Value

accumulated depreciation is deducted from the cost of the asset

Capitalized

added to an asset account

The straight-line method

allocates an equal amount of an asset's cost to depreciation expense for each year of the asset's useful life (most used one)

At acquisition

an operating asset is recorded at its costs, including the cost of acquiring the asset and the cost of preparing the asset for use (historical principle).

Natural resources

are naturally occurring materials that have economic value. They include timberlands and deposits such as coal, oil, and gravel.

Depletion

as a natural resource is removed from the earth, the cost of the natural resource is allocated to each unit if natural resource removed.

Equipment

assets used in operations (machinery, furniture, automobiles).

Depletion rate =

cost - residual value / recoverable units

Components of depreciation expense

cost - residual value = depreciable cost /useful life

Book value is equal to

cost minus accumulated depreciation

Is necessary to measure depreciation:

cost of the fixed asset, useful life (or expected life) of the fixed asset, residual value (salvage value) of the fixed asset.

Declining balance depreciation expense

declining balance rate X book value

Depletion =

depletion rate X units recovered (will debit the depletion value as an inventory and credit accumulated depletion).

Units-of-production depreciation expense

depreciation cost per unit X actual usage of the asset

The impairment test consists of two steps:

existence: an impairment exists if the future cash flows expected to be generated by the asset are less than the asset's book value. measurement: if an impairment exists, the impairment loss is measured as the difference between the book value and the fair value of the asset.

Expensed

expenditures that are NOT included as part of the cost of the asset (expensed immediately).

Capitalized

expenditures that are include as part of the cost of the asset

Revenue expenditures

expenditures that do not increase the future economic benefits of the asset and expensed in the same period the expenditure is made.

Extraordinary or major repairs additions

expenditures that extend the asset's useful life ( overhaul or rebuilding of an engine, fixing structural damage to a building)/ adding a new or major component to an existing asset (adding a new wing to a building, installing a pollution-control device on a machine.- accounting treatment( capitalize and depreciate over the asset's remaining useful life/ capitalize and depreciate over the shorter of the remaining life of the asset or the addition).

Capital expenditures

expenditures that extend the life of the asset, expand the productive capacity, increase efficiency, or improve the quality of the product. (added to an asset account and are subject to depreciation).

Ordinary repairs and maintenance

expenditures that keep an asset in normal operating condition- examples (oil change for a truck, painting of a building, replacement of a minor part, normal cleaning cost)- accounting treatment (expense in the current period).

An impairment

is a permanent decline in the future benefit or service potential of an asset.

Declining balance method

is an 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.

The cost of a fixed asset

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

Accumulated depreciation

is reported on the balance sheet as a contra-asset.

Depreciation

is reported on the income statement.

The residual life (also called salvage value)

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

The useful life of an asset

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

Depreciation (land are not depreciated)

is the process of allocating, in a systematic and rational manner, the cost of tangible fixed asset (other than land) to expense over the asset's useful life.

Property, plant, and equipment includes:

land, land improvements, buildings, and equipment.

Intangible operating assets

like the tangible assets, represents future economic benefit to the company, but unlike tangible assets, they lack physical substance. (patents, copyrights, trademark, leaseholds, organization costs, franchises, and goodwill.

Fixed asset turnover ratio =

net sales / average net fixed assets ( the more efficiently a company uses its fixed assets, the higher the ratio will be).

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. The disposal may occur at the end of the asset's useful life or at some other time. For example, obsolescence due to unforeseen technological developments may lead to an earlier than expected disposition of the asset.

Property, plant, and equipment (PP&E)

often called fixed assets or plant assets, are tangible operating assets that can be seen and touched. They include, among other things, land, buildings, machines, and automobiles.

Types of expenditures

ordinary repairs and maintenance, extraordinary or majors repairs additions, and improvements ( or betterments).

Building cost includes:

purchase price, closing costs, architectural fees, cost of building permits, excavation costs, remodeling fees.

Land cost includes:

purchase price, real state commissions, delinquent property taxes, closing costs (attorney, title, and survey fees), clearing and grading costs, demolition of unwanted buildings, minus salvage.

Land improvements cost includes:

purchase price, sales taxes, installation cost.

Equipment cost includes:

purchase price, sales taxes, transportation costs, insurance during transportation, installation costs, cost of trial runs.

Expensed

reported in total on the income statement

Accumulated Depreciation

should be equal to the depreciable cost at the end

Book Value

should be equal to the residual value at the end

Depreciation Methods

straight-line, declining balance, units-of-production (the total amount of depreciation expense that has been recorded -accumulated depreciation- over the life of the asset will never exceed the depreciable cost -cost minus residual value- of the asset.

Land improvements

structural additions or improvements to land (such as driveways, parking lots, fences, landscaping, lighting).

Buildings

structures used in operations (factory, office, warehouse).

Natural resources

such as coal deposits, oil reserves and mineral deposits, make up important part of the operating assets for many companies.

Amortization

the cost of an intangible asset with a finite life, like the cost of a tangible asset, is allocated to accounting periods over the life of the asset to reflect the decline in service potential (indefinite life it is not amortized but is reviewed as least annually for impairment).

Operating assets are

the long-lived assets that are used by the company in the normal course of operations. Unlike inventory, operating assets are not sold to customers. Instead, operating assets are used by a company in the normal course of operations to generate revenue.

Improvements (or betterments)

the replacement of a component of an asset with a better one that increases efficiency or productivity - examples (replacing an old air conditioning unit with a more efficient one, replacing a manual machine control with computer- controlled controls) - accounting treatment( capitalized and depreciate over the improved asset's remaining useful life).

Land

the site of manufacturing facility or office building used in operations. (Land purchased for future use or as an investment is not considered part of property, plant, and equipment.

Operating assets are held until

their service potential has been exhausted.

Natural resources differences

unlike fixed assets, natural resources are physically consumed as they are used by a company. natural resources can generally be replaced or restored only by an act of nature. (Timberlands are renewed by replanting and growth, but coal deposits and most mineral deposits are not subject to renewal).

Disposal of fixed assets

voluntary disposal and involuntary disposal

Units-of-production method

when the decline in asset's service potential is proportional to the usage of the asset and asset usage can be measured, depreciation expense can be computed using this method.

Intangible assets

which generally result from legal and contractual rights, do not have physical substance. They include patents, copyrights, trademarks, licenses, and goodwill.

These costs are said to be capitalized

which means that they are reported as long-term assets with a service potential of greater than 1 year.