GPC Accounting Chapter 9

Cost of land includes

(1) the cash purchase price, (2) closing costs such as title and attorney's fees, (3) real estate brokers' commissions, and (4) accrued property taxes and other liens on the land assumed by the purchaser.

More on Goodwill

In recording the purchase of a business, a company debits the identifiable acquired assets and credits liabilities at their fair values, credits cash for the purchase price, and records the difference as the cost of goodwill. Goodwill is not amortized because it is considered to have an indefinite life. However, it must be written down if a company determines the value of goodwill has been permanently impaired.

straight-line

Intangible assets are typically amortized on a ____________basis. For example, the legal life of a patent is 20 years. Companies amortize the cost of a patent over its 20-year life or its useful life, whichever is shorter.

limited, indefinite life

Intangibles are categorized as having either a limited life or an indefinite life. If an intangible has a_____________, the company allocates its cost over the asset's useful life using a process similar to depreciation. The process of allocating to expense the cost of intangibles is referred to as amortization. The cost of intangible assets with ____________ lives should not be amortized.

Interest costs on buildings

Interest costs incurred to finance a construction project are included in the cost of the asset when a significant period of time is required to get the asset ready for use. In these circumstances, interest costs are considered as necessary as materials and labor. However, the inclusion of interest costs in the cost of a constructed building is limited to interest costs incurred during the construction period. When construction has been completed, subsequent interest payments on funds borrowed to finance the construction are recorded as increases (debits) to Interest Expense.

depreciate

Land does not _______________.

Cost, useful life, salvage value

Three factors affect the computation of depreciation are

profit margin

That ratio is calculated by dividing net income by net sales. It tells how effective a company is in turning its sales into income—that is, how much income each dollar of sales provides.

cost of equipment

The ___________________ consists of the cash purchase price, sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit.

historical cost principle

The ________________________ requires that companies record plant assets at cost

fair value

The amount that a business could sell an asset for, or the amount that a business could pay to settle a liability. In fact, if an asset is fully depreciated, it can have zero book value but still have a significant fair value. Like a classic car.

book value

The current value for accounting purposes of an asset expressed as original cost plus capital additions minus accumulated depreciation.

Intangible assets

These assets, such as copyrights and patents, lack physical substance but can be extremely valuable and vital to a company's success.

Recording intangibles

To record amortization of an intangible asset, a company increases (debits) Amortization Expense, and decreases (credits) the specific intangible asset. (Unlike depreciation, no contra account, such as Accumulated Amortization, is usually used.)

Recording an amortization

To record amortization of an intangible asset, a company increases (debits) Amortization Expense, and decreases (credits) the specific intangible asset. (Unlike depreciation, no contra account, such as Accumulated Amortization, is usually used.) Intangible assets are typically amortized on a straight-line basis.

book value

Whatever the disposal method, the company must determine the ____________of the plant asset at the time of disposal in order to determine the gain or loss. Recall that the book value is the difference between the cost of the plant asset and the accumulated depreciation to date. If the disposal occurs at any time prior to the end of the year, the company must record depreciation for the fraction of the year to the date of disposal. The company then eliminates the ______________ by reducing (debiting) Accumulated Depreciation for the total depreciation associated with that asset to the date of disposal and reducing (crediting) the asset account for the cost of the asset.

purchased

When a building is __________, such costs include the purchase price, closing costs (attorney's fees, title insurance, etc.), and real estate broker's commission. Costs to make the building ready for its intended use consist of expenditures for remodeling rooms and offices and replacing or repairing the roof, floors, electrical wiring, and plumbing.

prior periods

When a change in an estimate is required, the company makes the change in current and future years but not to ___________. Thus, when making the change, the company (1) does not correct previously recorded depreciation expense, but (2) revises depreciation expense for current and future years.

intangible asset

When a company can identify costs with the acquisition of the franchise or license, it should recognize an _________________. Companies record as operating expenses annual payments made under a franchise agreement in the period in which they are incurred. In the case of a limited life, a company amortizes the cost of a franchise (or license) as operating expense over the useful life. If the life is indefinite or perpetual, the cost is not amortized.

significant

When a company has ____________ intangibles, analysts should evaluate the reasonableness of the useful life estimates that the company discloses in the notes to its financial statements. In determining useful life, the company should consider obsolescence, inadequacy, and other factors. These may cause a patent or other intangible to become economically ineffective before the end of its legal life.

constructed

When a new building is ___________, its cost consists of the contract price plus payments made by the owner for architects' fees, building permits, and excavation costs.

Straight line

With __________________depreciation, the depreciation expense is the same each year. The book value at the end of the useful life is equal to the estimated salvage value.

Useful life

_________ is an estimate of the expected productive life, also called service life, of the asset for its owner. It may be expressed in terms of time, units of activity (such as machine hours), or units of output. It is an estimate. In making the estimate, management considers such factors as the intended use of the asset, repair and maintenance policies, and vulnerability of the asset to obsolescence. The company's past experience with similar assets is often helpful in deciding on this.

extending

____________ an asset's estimated life reduces depreciation expense and increases current period income.

copyrights

give the owner the exclusive right to reproduce and sell an artistic or published work. Copyrights last for the life of the creator plus 70 years. The cost of the copyright consists of the cost of acquiring and defending it. The cost may be only the small fee paid to the U.S. Copyright Office, or it may amount to a great deal more if a copyright is acquired from another party. The useful life of a copyright generally is significantly shorter than its legal life.

increase its return on assets

if a company wants to_____________________________, it can do so in two ways: (1) by increasing the margin it generates from each dollar of goods that it sells (the profit margin), or (2) by increasing the volume of goods that it sells (the asset turnover).

asset turnover

indicates how efficiently a company uses its assets to generate sales—that is, how many dollars of sales a company generates for each dollar invested in assets. It is calculated by dividing net sales by average total assets. When we compare two companies in the same industry, the one with the higher asset turnover is operating more efficiently.

Salvage value

is an estimate of the asset's value at the end of its useful life for its owner. Companies may base the value on the asset's worth as scrap or on its expected trade-in value. Like useful life, it is an estimate. In making the estimate, management considers how it plans to dispose of the asset and its experience with similar assets.

patent

is an exclusive right issued by the U.S. Patent Office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant. The initial cost of a patent is the cash or cash equivalent price paid to acquire the patent.

depreciation

is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Such cost allocation is designed to properly match expenses with revenues.

When it comes to assets

it is important for a company to (1) keep assets in good operating condition, (2) replace worn-out or outdated assets, and (3) expand its productive assets as needed.

capital lease

lessees show both the asset and the liability on the balance sheet. The lessee accounts for capital lease agreements in a way that is very similar to debt-financed purchases: The lessee shows the leased item as an asset on its balance sheet, and the obligation owed to the lessor as a liability. The lessee depreciates the leased asset in a manner similar to purchased assets.

Plant assets

long-lived assets, such as land, buildings, and equipment, used in the operation of the business. Also called fixed assets.

return of assets

profit margin x asset turnover

Depreciable cost

represents the total amount subject to depreciation; it is calculated as the cost of the plant asset less its salvage value. Cost - Salvage value.

Goodwill

represents the value of all favorable attributes that relate to a company that are not attributable to any other specific asset. These include exceptional management, desirable location, good customer relations, skilled employees, high-quality products, fair pricing policies, and harmonious relations with labor unions. Goodwill is unique because unlike other assets such as investments, plant assets, and even other intangibles, which can be sold individually in the marketplace, goodwill can be identified only with the business as a whole. Companies record goodwill only when there is an exchange transaction that involves the purchase of an entire business. When an entire business is purchased, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.

earnings management

the practice of timing the recognition of gains and losses to achieve certain income results is known as ____________________. It reduces earnings quality. To minimize this, accounting standards now require immediate loss recognition on impaired assets.

return on assets and asset turnover.

two measures to analyze plant assets are:

lease

A _________ is a contractual agreement in which the owner of an asset (the lessor) allows another party (the lessee) to use the asset for a period of time at an agreed price.

Franchise

A business established or operated under an authorization to sell or distribute a company's goods or services in a particular area.

impairments

A permanent decline in the fair value of an asset. So as not to overstate the asset on the books, the company writes the asset down to its new fair value during the year in which the decline in value occurs.

capital expenditures

Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset. These expenditures are usually material in amount and occur infrequently during the period of ownership. Expenditures for additions and improvements increase the company's investment in productive facilities and are generally debited to the plant asset affected. Thus, they are_______________________.

land

All necessary costs incurred in making land ready for its intended use increase (debit) the Land account. When a company acquires vacant land, its cost includes expenditures for clearing, draining, filling, and grading. If the land has a building on it that must be removed to make the site suitable for construction of a new building, the company includes all demolition and removal costs, less any proceeds from salvaged materials, in the Land account. Price of property + other costs = cost of land.

Intangible assets

An asset that is not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights), goodwill, and brand recognition are common intangible assets.

revenue expenditures

expenditures that are immediately charged against revenues as an expense

Return on assets

1.) computed by dividing net income by average assets. (Average assets are commonly calculated by adding the beginning and ending values of assets and dividing by 2.) indicates the amount of net income generated by each dollar of assets. Thus, the higher it is, the more profitable the company.

Advantage of lease verse a purchase

1.Reduced risk of obsolescence. Frequently, lease terms allow the party using the asset (the lessee) to exchange the asset for a more modern one if it becomes outdated. This is much easier than trying to sell an obsolete asset. 2. Little or no down payment. To purchase an asset, most companies must borrow money, which usually requires a down payment of at least 20%. Leasing an asset requires little or no down payment. 3. Shared tax advantages. Startup companies typically earn little or no profit in their early years, and so they have little need for the tax deductions available from owning an asset. In a lease, the lessor gets the tax advantage because it owns the asset. It often will pass these tax savings on to the lessee in the form of lower lease payments. 4. Assets and liabilities not reported. Many companies prefer to keep assets and especially liabilities off their books. Reporting lower assets improves the return on assets (discussed later in this chapter). Reporting fewer liabilities makes the company look less risky. Certain types of leases, called operating leases, allow the lessee to account for the transaction as a rental, with neither an asset nor a liability recorded.

license

Another type of franchise is a license. Licenses granted by a governmental body permit a business to use public property in performing its services. Examples are the use of city streets for a bus line or taxi service; the use of public land for telephone, electric, and cable television lines; and the use of airwaves for radio or TV broadcasting.

indefinite

Because trademarks and trade names have __________lives, they are not amortized.

double-declining-balance

Companies can apply the declining-balance approach at different rates, which result in varying speeds of depreciation. A common declining-balance rate is double the straight-line rate. Using that rate, the method is referred to as the ___________________method.

With a sale, exchange, or retirement

Companies dispose of plant assets that are no longer useful to them.

disclose

Companies must ____________ the choice of depreciation method in their financial statements or in related notes that accompany the statements.

"Other expenses and losses"

Companies report a loss on disposal of the plant asset in the__________________________ section of the income statement.

Retirement of Plant Assets

Companies simply retire, rather than sell, some assets at the end of their useful life. For example, some productive assets used in manufacturing may have very specific uses, and they consequently have no ready market when the company no longer needs them. In such a case, the asset is simply retired. Companies record retirement of an asset as a special case of a disposal where no cash is received. They decrease (debit) Accumulated Depreciation for the full amount of depreciation taken over the life of the asset and decrease (credit) the asset account for the original cost of the asset. The loss (a gain is not possible on a retirement) is equal to the asset's book value on the date of retirement.

Cash equivalent price

Cost is measured by the cash paid in a cash transaction or by the cash equivalent price paid when companies use non-cash assets in payment. The cash equivalent price is equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.

Depreciation expense

Depreciable cost / useful life

accumulated depreciation, expense

Depreciation affects the balance sheet through__________________, which companies report as a deduction from plant assets. It affects the income statement through depreciation _______________.

land improvements, buildings, and equipment

Depreciation applies to three classes of plant assets, they are:_____________,_______________,____________and are considered depreciable assets.

plant assets

Depreciation expense is reported on the income statement. Accumulated depreciation is reported on the balance sheet as a deduction from _____________.

Units-of-activity

Depreciation is generally computed using one of three methods: 1. Straight-line 2. Declining-balance 3. _______________. Each of these depreciation methods is acceptable under generally accepted accounting principles. Management selects the method it believes best measures an asset's contribution to revenue over its useful life. Once a company chooses a method, it should apply that method consistently over the useful life of the asset. Consistency enhances the ability to analyze financial statements over multiple years.

repairs, additions, and improvements

During the useful life of a plant asset, a company may incur costs for ordinary__________, _____________, _______________.

capital expenditures

Expenditure that increase the capacity or efficiency of an asset or extend its useful life. They are debited to an asset account. Not immediately expensed.

MACRS

For tax purposes, taxpayers must use on their tax returns either the straight-line method or a special accelerated-depreciation method called the Modified Accelerated Cost Recovery System.

Debit equipment, expenses, and /or insurance, credit cash

How would a company record a truck purchase?

Debit accumulated depreciation equipment and loss on disposal, credit equipment.

How would you account for the retirement of equipment?

Debit cash(sale amount) and accumulated depreciation(of asset), credit equipment(original cost) and gain on disposal(calculated).

How would you record the sale and the gain on sale of the plant asset?

Debit cash, accumulated depreciation-equipment, loss on disposal, and credit equipment.

How would you record the sale and the loss on sale of the plant asset?

limited life

If an intangible has a limited life, the company allocates its cost over the asset's useful life using a process similar to depreciation. The process of allocating to expense the cost of intangibles is referred to as amortization. The cost of intangible assets with indefinite lives should not be amortized.

patent legal costs

If the owner incurs legal costs in successfully defending the patent in an infringement suit, such costs are considered necessary to establish the validity of the patent. Thus, the owner adds those costs to the Patent account and amortizes them over the remaining life of the patent.

loss on disposal

If the proceeds from the sale are less than the book value of the plant asset sold, a ______________occurs.

gain on disposal

If the proceeds from the sale exceed the book value of the plant asset, a_________________occurs.

review

Management should periodically __________ annual depreciation expense. If wear and tear or obsolescence indicates that annual depreciation is either inadequate or excessive, the company should change the depreciation expense amount.

declining balance method

Method that determines depreciation charge for the period by multiplying a depreciation rate (often twice the straight-line rate) by the asset's beginning-period balance. Computes depreciation expense using a constant rate applied to a declining book value. This method is called an accelerated-depreciation method because it results in higher depreciation in the early years of an asset's life than does the straight-line approach. However, because the total amount of depreciation (the depreciable cost) taken over an asset's life is the same no matter what approach is used, the declining-balance method produces a decreasing annual depreciation expense over the asset's useful life. In early years, declining-balance depreciation expense will exceed straight-line, but in later years, it will be less than straight-line. Managers might choose an accelerated approach if they think that an asset's utility will decline quickly.

How effective is the company at generating sales from its assets?

Need to know net sales and average total assets. Use the asset turnover ratio. The results indicate the sale dollars generated per dollar of assets. A high value suggests the company is effective in using its resources to generate sales.

cash

Recognizing depreciation for an asset does not result in the accumulation of ______ for replacement of the asset. The balance in Accumulated Depreciation represents the total amount of the asset's cost that the company has charged to expense to date; it is not a cash fund.

straight line depreciation

Reducing a long-term asset by the same about every year until residual value is reached((purchase price minus residual value) divided by years of use).

useful life

________________ is expressed in terms of the total units of production or the use expected from the asset. The units-of-activity method is ideally suited to factory machinery: Companies can measure production in terms of units of output or in terms of machine hours used in operating the machinery. It is also possible to use the method for such items as delivery equipment (miles driven) and airplanes (hours in use). The units-of-activity method is generally not suitable for such assets as buildings or furniture because activity levels are difficult to measure for these assets.

Obsolescence

___________________ is the process by which an asset becomes out of date before it physically wears out.

Equipment

______________includes assets used in operations.

Annual

___________depreciation expense varies considerably among the methods, but total depreciation expense is the same ($12,000) for the five-year period.

Research and development costs

are expenditures that may lead to patents, copyrights, new processes, and new products. are recorded as an expense in the period incurred.

Ordinary repairs

are expenditures to maintain the operating efficiency and expected productive life of the unit. They usually are fairly small amounts that occur frequently throughout the service life. Examples are motor tune-ups and oil changes, the painting of buildings, and the replacing of worn-out gears on factory machinery. Are debited to Maintenance and Repairs Expense as incurred.

Plant asset

are resources that have physical substance (a definite size and shape), are used in the operations of a business, and are not intended for sale to customers. They are called various names—property, plant, and equipment; plant and equipment; and fixed assets. By whatever name, these assets are expected to provide service to the company for a number of years. Except for land, plant assets decline in service potential (ability to produce revenue) over their useful lives.

intangible assets

are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. They are recorded at cost. Many companies' most valuable assets are intangible. They may arise from 1. Government grants, such as patents, copyrights, licenses, trademarks, and trade names. 2. Acquisition of another business in which the purchase price includes a payment for goodwill. 3. Private monopolistic arrangements arising from contractual agreements, such as franchises and leases.

land improvements

are structural additions made to land, such as driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use.

annual depreciation rate

calculated by 100 % x useful life years. If its in months you would 100 % x (# months /12)

cost

companies record plant assets at cost, in accordance with the historical cost principle.

annual recurring expenditures

companies treat as expenses the costs of motor vehicle licenses and accident insurance on company trucks and cars. Such items are _____________________________and do not benefit future periods.

Cost

consists of all expenditures necessary to acquire an asset and make it ready for its intended use.

cost allocation

depreciation is a______________ process, not an asset valuation process.

annual depreciation expense

divide depreciable cost by the estimated useful life.