Financial Accounting Fundamentals Chapter 8

Declining-balance depreciation method:

Assigns more depreciation to early years of an asset's life and less depreciation to later years.

T/F: Choose the units-of-production depreciation method if the amount of asset production varies significantly from period to period.

True

T/F: Declining-balance method apply best to assets that are most productive when they are new but quickly lose their usefulness as they get older.

True

T/F: Different depreciation methods can be used for different classes of assets provided the methods are used consistently over time so that financial statement users can compare results across periods.

True

T/F: GAAP doesn't allow the reporting of Goodwill as an intangible asset on the balance sheet unless it has been purchased from another company.

True

T/F: Gains on disposal are included in the income statement.

True

T/F: Land is never used up, so any costs assigned to Land will remain in that account until it is sold.

True

T/F: Land is the only tangible asset that's assumed to have an unlimited (indefinite) useful life. Because of this, land is not depreciated.

True

T/F: The IRS allows companies to deduct larger amounts of tax depreciation in the early years of an asset's life than what GAAP allows.

True

T/F: The Income Statement account, Depreciation Expense, reports the depreciation of the current period.

True

T/F: The Straight-line method is the preferred choice because it is the easiest to use and understand, and it does a good job of matching depreciation expense to revenues when assets are used evenly over their useful lives.

True

T/F: The amount of depreciation expense recorded in each year of an asset's life depends on the method that is used. That means that the amount of net income that is reported can vary, depending on the depreciation method used.

True

T/F: The balance sheet account, Accumulated Depreciation, contains the current period's depreciation as well as that of prior periods.

True

T/F: The basic idea of depreciation is to match the economic benefit that will be used up (asset cost minus residual value) to the periods the asset will be used to generate revenue (useful life).

True

T/F: The costs of intangible assets are recorded as assets only if they have been purchased.

True

T/F: The general rule for tangible assets under the cost principle is that all reasonable and necessary costs to acquire and prepare an asset for use should be recorded as a cost of the asset.

True

T/F: The units-of-production method is the typical choice when asset use fluctuates significantly from period to period.

True

T/F: Under the units-of-production method, the depreciation expense, accumulated depreciation, and book value vary from period to period, depending on the number of units produced.

True

T/F: In some cases, land, buildings, and equipment are purchased together. When this type of "basket purchase" occurs, the total cost is split among the assets in proportion to the market value of the assets as a whole.

True; Splitting the total purchase price among individual assets is necessary because they may be used over different periods.

T/F: If a company buys land, a building, or a piece of used equipment and incurs demolition, renovation, or repair costs before it can be used, these additional costs would be capitalized as a cost of the land, building, or equipment.

True; These costs are capitalized because they are needed to prepare the asset for use.

T/F: Under the straight-line and declining-balance methods, the annual depreciation is multiplied by the fraction of the year for which depreciation is being calculated.

True; These partial-year modifications are not required in the units-of-production method because that method is based on actual production for the period.

Leasehold improvements

Type of Intangible asset which are alterations and improvements to leased property , such as partitions, painting, and storefronts

Trademarks and trade names

Type of Intangible asset which are symbols, names, phrases, or singles identified with a company, product, or service

Leasehold

Type of Intangible asset which is the rights to possess and use leased property granted by the property's owner (lessor) to the lessee in a contract called a lease. As leaseholds are amortized, the cost is charged to rent expense

PT Co. purchased land and an existing building for $200,000. In addition, PT paid real estate commissions of $15,000. PT removed the unwanted building and graded the land for a total cost of $35,000. PT should record the cost of the land at:

$200,000+$15,000+$35,000=$250,000

Wen Co. purchased a building for $200,000. Wen paid $20,000 in lawyer and title fees. Wen also paid an additional $15,000 to modify the building in order to accommodate his business needs. Wen should record the cost of the building at:

$200,000+$20,000+$15,000=$235,000

Alin Co. purchases a building for $300,000 and pays an additional $30,000 for title fees and lawyer fees. Alin also pays $20,000 in renovations, including painting, carpet, lighting, etc. Alin should record the cost of the building at:

$300,000+$30,000+$20,000=$350,000

Depreciation calculations are based on the following three items:

Asset Cost Useful Life Residual Value

Residual (or Salvage) value:

The estimated amount to be recovered at the end of the company's estimated useful life of an asset.

Copyright

Type of Intangible

Geo Co. purchased a building for $400,000. In addition, Geo paid $35,000 for taxes and lawyer fees. Geo also paid $60,000 to modify the building, changing the layout specifically for Geo's needs. Geo should record the building at

$400,000+$35,000+$60,000=$495,000

Straight-Line

(1) Depreciation Expense is a constant amount each year. (2) Accumulated Depreciation increases by an equal amount each year. (3) Book Value decreases by the same equal amount each year. Allocates the depreciable cost of an asset in equals periodic amounts over its useful life. (Cost - Residual Value) x 1/Useful life = Depreciation Expense

The disposal of a depreciable assets usually requires two accounting adjustments:

(1) Update the Depreciation Expense and Accumulated Depreciation accounts. (2) Record the disposal. (2.1) account for the book value of the items given up (2.2) account for the value of the items received on disposal (2.3) any difference between the two amounts, which reflects a gain or loss on the disposal to be reported on the income statement.

Units-of-production formula

(Cost - Residual Value) x Actual Production This Period/ Estimated Total Production = Depreciation Expense

Reporting Depreciation

1. Cost of plant assets and accumulated depreciation are reported on the balance sheet or in the notes 2. To satisfy the full-disclosure principle, the depreciation method or methods used must be disclosed in a balance sheet note 3. Plant assets are reported at their undepreciated costs, not at fair value 4. Accumulated depreciation on the balance sheet does not represent funds accumulated to buy new assets when the presently owned assets must be replaced

General Accounting Steps in a disposal of a plant asset

1. Record depreciation up to the date of disposal 2. Remove account balances of the disposed asset 3. Record any cash received or paid in the disposal 4. Record any gain or loss resulting from comparing the asset's book value with the market value of any assets received

T/F: Amortization is reported as an expense each period on the income statement and accumulated on the balance sheet in the contra-asset account Accumulated Amortization.

True

Franchise:

A contractual right to sell certain products or services, use certain trademarks, or perform activities in a certain geographical region.

Lump Sum Purchase

A group of plant assets purchased as a single transaction for a lump sum price.

Constructed Buildings

A plant asset constructed for own use. Costs includes materials and labor plus reasonable amount of indirect overhead

Land Improvements

A plant asset which includes the costs that increase the usefulness of the land. Costs are charged to a separate land improvement account. Costs are depreciated. Examples:Assets that increase the benefits of land, have a limited useful life, such as parking lots and lighting systems

Land

A plant asset who costs include purchase price, real estate commissions, title insurance, legal fees, accrued property taxes, surveying, clearing, landscaping, and local government assessments

Patent:

A right to exclude others from making, using, selling, or importing an invention.

Technology asset:

Acquired computer software and development costs,

EBITDA:

An abbreviation for "earning before interest, taxes, depreciation and amortization" which is a measure of operating performance that some managers and analyst use in place of net income.

T/F: As a result of recording depreciation, an asset's book value declines as it ages.

True

Plant assets should be recorded at cost, including all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use. This would include which of the following costs?

Assembling Shipping charges Testing

Disposal of Plant Assets

Assets may be discarded, sold, or exchanged due to wear and tear, obsolescence, inadequacy, or damage by fire or other accident.

property, plant, and equipment

Assets such as machinery and equipment, buildings, and land, used to produce products or to carry on the administrative and selling functions of a business; sometimes called plant assets.

Natural resources

Assets that are physically consumed when used. Example includes timber, oil, mineral deposits. Often called wasting assets

tangible assets

Assets that have physical form, such as equipment, machinery, natural resources, and land.

long-term operational assets

Assets used by a business, normally over multiple accounting periods, to generate revenue; contrast with assets that are sold (inventory) or held (investments) to generate revenue; also called productive assets.

Book Value

Cost minus Accumulated Depreciation

Depreciation Cost

Cost minus Salvage Value

revenue expenditures

Costs incurred for repair or maintenance of long-term assets: recorded as expense and subtracted from revenue in the accounting period in which incurred. Related to specific revenue transactions or operating periods. Examples: COGS or Maintenance Expense

depreciation

Decline in value of long-term tangible assets such as buildings, furniture, or equipment. Original cost minus salvage value (of a long-term depreciable asset). he process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use. Recorded as a debit to a Depreciation Expense and credited to Accumulated Depreciation

double-declining-balance depreciation

Depreciation computations that produce larger amounts of depreciation in the early years of an asset's life and progressively smaller amounts as the asset ages. (Cost-Accumulated Depreciation) x 2/Useful life = Depreciation Expense

units-of-production depreciation

Depreciation computations that produce varying amounts of depreciation based on the level of an asset's usage each period rather than a measure of time; for example, automobile depreciation may be based on total estimated miles to be driven rather than total estimated years to be used. (Cost - Residual Value) x Actual Production This Period/ Estimated Total Production = Depreciation Expense

T/F: Because depreciation is not intended to report an asset at its current value, an asset's book value could exceed its current value, particularly if the asset becomes impaired,

True

accelerated depreciation method

Depreciation method that recognizes more depreciation expense in the early stages of an asset's life than the straight-line method and less later in the asset's life.

Which of the following items are plant assets?

Equipment being used in operations Building being used for operations

franchise

Exclusive right to sell products or perform services in certain geographic areas.

Ordinary Repairs and Maintenance: (Sometimes called Revenue Expenditures)

Expenditures for routine operating upkeep of long -lived assets; they are recorded as expenses.

Extraordinary repairs, replacements, and additions: (Sometimes called capital expenditures)

Expenditures that extend the useful life of a tangible asset or improve its output in the future; they are recorded as increases in asset amounts, not as expenses.

Research and Development

Expenditures that may someday lead to patents, copyrights, or other intangible assets; the uncertainty about their future benefits requires that they be expensed.

carrying value

Face amount of a bond liability less any unamortized bond discount or plus any unamortized bond premium.

Obsolescence

Factor affecting useful life referring to a plant asset that is no longer useful in producing goods or services with a competitive advantage because of new inventions and improvements

Inadequacy

Factor affecting useful life which is the insufficient capacity of plant assets to meet the company's growing productive demands

Cost

Factor in computing depreciation

Salvage value

Factor in computing depreciation which is an estimate of the asset's value at the end of its benefit period

Modified Accelerated Cost Recovery System (MACRS)

Federal income tax law rules for depreciating assets. Not acceptable for financial reporting

Revising Depreciation

If estimated salvage and /or useful life is revised: Depreciation expense computations are revised by spreading the remaining cost to be depreciated over the revised useful life remaining

deferred tax liability

Income tax payment postponed until future years because of the difference in accounting methods selected for financial reporting and methods required for tax purposes (e.g., a company may use straight-line depreciation in financial statements but use MACRS for tax reporting).

The cost at which a company records purchases of machinery and equipment should include which of the following?

Installation Taxes Shipping fees Purchase price

goodwill

Intangible added value of a successful business attributable to such factors as reputation, location, and superior products that enables the business to earn above-average profits; measured by an entity acquiring the business as the excess paid over the appraised value of the net assets.

Unlimited Life.

Intangibles with unlimited or indefinite lives (trademarks and most goodwill) are not amortized.

Betterments (Improvements

Involves adding a component to an asset that doesn't always extend its useful life - Example includes adding wiring to a building -Debited to the asset account -The increase in asset's book value results in need to revise future depreciation An expenditure to make a plant asset more efficient or productive. Both are treated as a capital expenditure

copyright

Legal protection of writings, musical compositions, and other intellectual property for the exclusive use of the creator or persons assigned the right by the creator.

patent

Legal right granted by the U.S. Patent Office ensuring a company or an individual the exclusive right to a product or process.

capital expenditures

Major investments in either tangible long-term assets such as land, buildings, and equipment or intangible assets such as patents, trademarks, and copyrights.(sometimes called balance sheet expenditures)

relative fair market value method

Method of allocating the purchase price among individual assets acquired in a basket purchase; each asset is assigned a percentage of the total price paid for all assets. The percentage assigned equals the market value of a particular asset divided by the total of the market values of all assets acquired in the basket purchase.

Fixed asset turnover ratio

Net revenue/ Average Net Fixed Assets

Impairment:

Occurs when the cash to be generated by an asset is estimated to be less than the carrying value of that asset.

depreciation expense

Portion of the original cost of a long-term tangible asset allocated to an expense account in a given period.

Cost determination of Intangible Assets

Recorded at cost when purchased Amortization Gross Acquisition Cost is disclosed on the balance sheet along with the accumulated amortization

Long-lived assets:

Resources owned by a business that enable it to produce the goods or services that are sold to customers.

Selling Plant Assets

Sale is at a gain if value received exceeds book value Sale is at a loss if value received is less than book value

Total Asset Turnover

Sales/Total Assets measure of a companies ability to use it's assets effectively

Change in an accounting estimate

Substantial amounts spent to improve an asset's quality or to extend its life. An expenditure to make a plant asset more efficient or productive. Both are treated as a capital expenditure

Two types of long-lived assets:

Tangible and Intangible

Plant Assets

Tangible assets used in a company's operations that have a useful life of more than one accounting period. Recorded at cost. Cost includes all normal and reasonable expenditures to get the asset in place and ready for intended use. purchased as a group in a single transaction for a lump-sum price are allocated the purchase price based on their relative market values.

Depreciation:

The allocation of the depreciable cost of long-lived tangible assets over their productive lives using a systematic and rational method.

Limited Life.

The cost of intangible assets with a limited life (copy rights, patents, licensing rights, and franchise) is spread on a straight-line basis over each period of useful life in a process called amortization.

Useful Life:

The expected service life of an asset to the present owner. Factor in computing depreciation which is the length of time the asset is expected to be productively used in a company's operations.

Licensing rights:

The limited permission to use property according to specific terms and conditions set out in a contract.

T/F: Because residual value is not included in the formula for the declining-balance method of computing depreciation expense, you must take extra care to ensure that an asset's book value is not depreciated beyond its residual value.

True

amortization

The paying off of debt with a fixed repayment schedule in regular installments over a period of time. Consumers are most likely to encounter this type of debt repayment with a mortgage or car loan. Book def.: Systematic and periodic allocation of the costs of intangible assets to expense over their useful lives; (2) periodically transferring the discount on a note or a bond to interest expense.

Depletion

The process of allocating the cost of natural resources to the period when it is consumed

Depreciable Costs:

The proportion of the asset's costs that will be used in generating revenue; calculated as asset cost minus residual value. Original cost minus salvage value (of a long-term depreciable asset).

Net assets:

The shorthand term used refer to assets minus liabilities.

T/F: Capitalizing costs has a significant impact on both the balance sheet (it increases assets) and the income statement (it decreases expenses).

True

Tangible Assets:

These are long-lived assets that have physical substance, which simply means that you can see, touch, or kick them. EX: land, buildings, machinery, vehicles, office equipment, and furniture and fixtures. These assets are grouped into a single line on the balance sheet called Property, Plant and Equipment. Also, known as fixed assets because they are often fixed in place.

Additional Expenditures

Those made to operate, maintain, repair or improve plant assets after their initial purchase.

estimated useful life

Time period for which a business expects to use an asset.

Capitalize:

To record a cost as an asset, rather than an expense.

T/F: A gain (or loss) on disposal represents the difference between the proceeds from selling the asset and the asset's book value (BV).

True

Partial Year Depreciation

When an asset is purchased or disposed of at a time other than the beginning or end of an accounting period, depreciation is recorded for part of the year

Lessee

a person who acquires the right to possession and use of goods under a lease

Depreciation for Tax Reporting

difference between financial and tax accounting systems. It is normal and expected

Ordinary Repairs

expenditures to keep an asset in normal, good operating condition. They do NOT materially increase the asset's life or productive capabilities - Treated as revenue expenditures - Recorded as expenses on the current period's income statement -Example cleaning, repainting, and lubricating

Lessor

landlord grants the lease

Discarding Plant Assets

no longer useful and has no market value If fully depreciated - No loss If not fully depreciated - record loss equal to book value

asset book value

original cost less accumulated depreciation of an asset

lease

property is rented under a contract a contract granting use or occupation of property during a specified time for a specified payment