Intermediate Exam #1

How do you calculate depletion cost per ton?

(cost - estimated residual value)/estimated tonnage

How do you calculate depreciation?

(cost - residual value)/life of asset

Straight Line Depreciation Method

(cost-estimated residual value)/ estimated service life

Declining - Balance Method

(multiple) X straight-line rate Depreciation Expense = Declining Balance Rate X Net Book Value @ Beginning of Period

Depreciation under Activity Method

1. Depreciation Rate = (cost-residual value)/estimated usage of the asset 2. Depreciation Expense = Depreciation Rate X Actual Usage of the Asset

How do you calculate asset impairment?

1. Recoverability Test 2. Measurement of the Loss

What characteristics are necessary for a company to include an asset in the category of property, plant and equipment?

1. held for use in operations, not investment 2. expected life of more than one year 3. tangible in nature (see and feel)

What is an operating expenditure?

A subsequent cost that does not increase the economic benefits but is incurred to maintain existing benefits and is expensed

What are the costs included in the acquisition of property, plant and equipment?

All costs necessary to obtain benefits derived from asset (total cost necessary to acquire asset & put it in operating condition)

What is the relationship between the book value of an asset during the life of the asset?

At the date of acquisition, the acquisition cost is equal to the fair value. At the end of the life of the asset,the book value should equal the residual value (a market value). During the life of the asset,there is no defined relationship between the book value and market value because depreciation is a process of cost allocation rather than of valuation.

How do you do the recoverability test?

Cost Less: Accumulated Dep = Book Value Calculate Undiscounted Expected Net Cash Flows= net cash flow X remaining years ** If undiscounted expected net cash flows is less than the book value there is an impairment loss

How do you compute the cost of a self-constructed asset?

Costs included are direct materials and labor, variable overhead and a pro rata share of fixed overhead

What justification does the FASB give for its treatment of unrealized holding gains and losses for trading securities?

FASB requires unrealized gains and losses to be reported as a component of income. It reasoned that because trading securities are actively managed, income measurement for these securities is more relevant if it includes the results of changes in fair value. In this manner, a company's net income includes the economic events that occur in a period. Therefore, this treatment should provide a better measure of the company's return on investment.

How do you calculate a gain?

FV of asset surrendered - BV of asset surrendered

Acquisition Costs: If management misclassified a portion of the buildings cost as part of the cost of land, what would be the effect on the financial statements?

If a portion of the cost of the building was misclassified as land, the amount reported for building would be understated and the amount reported for land would be overstated. However, in total, the initial amount reported for property, plant, and equipment would be correctly stated. Because depreciation would not be taken on the costs misclassified as land, property, plant, and equipment would be overstated in future periods. In addition, future income statements would understate depreciation expense, resulting in an overstatement of net income and shareholders' equity.

What factors should a company consider in estimating the useful life of an intangible asset?

In estimating the useful life of an intangible asset, a company should consider the following factors: 1. The expected use of the intangible asset 2. The expected useful life of another asset that is related to the life of the intangible asset 3. Any legal. regulatory, or contractual provisions that enable renewal or extension of the asset's legal or contractual life without substantial economic cost 4. The effects of obsolescence, demand, competition, and other economic factors 5. The level of maintenance costs required to obtain the expected future cash flows from the asset

How do you measure impairment loss?

Present Value of expected net cash flows (fair value) Impairment Loss = fair value - book value

What is the book value of an asset?

The book value of an asset is the recorded acquisition cost less the accumulated depreciation recorded to date.

How is the cost of PPE obtained by a non monetary exchange of assets?

The cost is the FV of the asset surrendered

What principle guides the determination costs of PPE?

The cost of the machine is determined as the fair value of the asset acquired or the sum of the fair value of the note payable and the preferred stock issued,whichever is more clearly evident.

What is the justification of accounting for the exchange differently when the exchange has commercial substance versus when it does not?

The different accounting is justified because when an exchange has commercial substance, the economic position of the two companies has changed and the company's future cash flows are expected to significantly change as a result of the exchange. Therefore, any gains and losses are recognized at the time of the exchange. However, when the exchange lacks commercial substance, the two companies are in the same economic position. Therefore, while conservatism allows losses to be recognized, a company will defer any gains until a transaction which alters the company's cash flows occurs.

What is the conceptual justification for the use of the equity method?

The equity method recognizes that a material economic relationship exists between the investor and the investee. Because of this relationship, the fair value is not appropriate because the investor could influence the amount of income it recognizes. Therefore, the earnings of the investee that were generated under the investors influence may not be faithfully represented in the investors financial statements. When significant influence exists, the use of the equity method more closely fits the requirements of the accrual accounting because the investor's share in investee income is reported in the period in which it is earned rather than as cash is received.

Explain the primary difference between US GAAP and IFRS with regard to the accounting and reporting or property, plant, and equipment.

The primary difference between U.S .GAAP and IFRS is that IFRS allow a company to subsequently value its property, plant, and equipment using either a cost model (similar to U.S. GAAP) or a revaluation model. Under the revaluation model, a company is allowed to write the value of its property, plant, and equipment up to fair value if fair value can be reliably measured. If the property, plant, and equipment is increased to fair value, the increase is recognized in other comprehensive income and accumulated in shareholders' equity as a revaluation surplus.If the fair value of the asset decreases, a company must first reduce any previously recognized revaluation surplus.Any remaining decrease is then recognized as an expense.

What are the three categories of minority passive investments in debt and equity securities? Describe the criteria used to classify the investment into these three categories.

The three categories of minority passive investments in debt and equity securities when there is no significant influence are: held-to-maturity securities, trading securities, and available-for-sale securities. Minority passive investments are classified into these three categories based on management intent. Investments in held-to-maturity securities are debt securities for which the company has the positive intent and ability to hold until maturity. Investments in trading securities are debt and equity securities that are purchased and held principally to sell in the near term. Investments in available-for-sale securities are debt and equity securities that are not classified as held-to-maturity or trading.

Should companies amortize trade names? Under what circumstances would the trade name be amortized?

Thetrade name would typically not be amortized because it isrenewable indefinitely as long as the trade name iscontinuously used. Therefore, trade names are considered to have an indefinite life and are not amortized; however, they are reviewed for impairment annually. Ifthe company later decides the life of the trade name isfinite (e.g., it plans to discontinue useof the trade name or does not intend to renew the trade name), its life is no longer considered to be indefinite and it would be amortized over its remaining useful life.

How does the measurement and reporting of impaired intangible assets differ between IFRS and US GAAP?

Three major differences exist between IFRS and U.S. GAAP with regard to the measurement and reporting of impaired intangible assets: • For intangible assets with a finite life, IFRS use a one-step approach to determine if an impairment exists instead of the two-step approach required by U.S. GAAP. • Under IFRS,Impairment losses are calculated as the difference between the carrying value of the intangible asset and its recoverable amount (the higher of the fair value less costs to sell or value in use). Because U.S. GAAP does not apply the value-in-use concept, the definition of fair value and the resulting amount of the impairment loss may be different between the two sets of standards. • For all intangible assets other than goodwill. IFRS allow any impairment losses to be reversed. Such reversals are not allowed under U.S. GAAP.

If Terry uses IFRS, how would the accounting for investments be different from US GAAP?

Under IFRS, the only significant difference would be the accounting and presentation of the unrealized holding gain. While the amount of the unrealized loss would be computed in the same manner, the unrealized holding gain/loss would be reported as a component of income. However, if Terry elects, at initial recognition, to have the unrealized holding gains and losses included in other comprehensive income, the accounting would be virtually identical to that under US GAAP.

Explain how a company accounts for the cost of its intangible assets.

When accounting for the cost of identifiable or unidentifiable intangibles, a company distinguishes between those that are externally acquired (purchased from others) and those that are internally developed. All purchased identifiable intangible assets are capitalized. Those purchased intangible assets with a finite life are amortized over their useful lives,while those with indefinite lives are reviewed for impairment. Purchased unidentifiable intangible assets(e.g., goodwill) are capitalized and reviewed for impairment (but not amortized). Internally developed intangible assets, whether identifiable or unidentifiable, are generally expensed as incurred. However, certain costs related to internally developed identifiable intangible assets are capitalized and amortized (if a finite life) or reviewed for impairment (if an indefinite life).

What does the method of depreciation effect?

companies income measurement, asset valuation, and rate of return on assets

How do you calculate the net book value of an asset?

cost - accumulated depreciation

What is depreciation a process of?

cost allocation, not asset valuation

How do you calculate cost?

fair value of asset surrendered + cash paid

What are included in research and development costs?

materials, equipment, facilities, personnel, intangibles purchased from others, contract services, and indirect costs

How do you calculate accumulated depreciation?

original cost - book value

How can companies dispose of property?

sale, involuntary conversion, abandonment or exchange

What are activity-based methods?

straight line, sum of digits, and declining balance (these are used when the service life of the asset is affected primarily by the passage of time

What do accounting principles require of the method of cost allocation used?

systematic and rational

When is the straight line method used?

when a company estimates that the service potential of the asset will decline by an approximately CONSTANT amount each period of its useful life

When are accelerated methods used?

when company estimates the service potential of the asset will decline more quickly in the early periods of the assets useful life than in later periods (more productive earlier)

When are activity methods used?

when the service life of the asset is affected primarily by the AMOUNT ASSET IS USED and not by the passage of time

When do companies test for impairment?

whenever events or changes in circumstances indicate the book value of the asset may not be recoverable.

How are intangible assets distinguished from tangible assets? What do they have in common?

Intangible assets are distinguished from tangible assets by the fact that intangibles do not have a physical or financial nature but do have value based on the rights and privileges they convey to the company that owns and uses them. These rights and privileges often arise from legal or contractual rights.In addition, intangible assets generally have a higher degree of uncertainty regarding their future economic benefits. In large part, this is due to the fact that their intangible nature makes them harder to separate and sell relative to tangible assets.Intangible and tangible assets do have characteristics in common since both are held for use in the course of business and not for investment, have useful lives of more than one year, derive their value from their ability to generate economic benefits for their owners, and may be expensed by a company in the periods in which they are used in operations (if the assets have finite lives).

Identify the accounting methods a company uses for investments of 20% or more in the voting common stock of the investee.

When an investor owns between 20% and 50% of the voting common stock of the investee, the investor is presumed to have significant influence over the investee. When this occurs, the equity method is used to account for the investment. Note that the 20% and 50% levels of ownership are guidelines in determining whether significant influence or control exists. For example, a company may own less than 20% of the voting common stock of the investee and still be considered to have significant influence. When the investor controls the investee, the investor issues consolidated financial statements of both companies. While legal control occurs when the investor owns more than 50% of the voting common stock of the investee, control can also be identified as the power to direct the use of the assets of the other investee in essentially the same way as the company can use its own assets. Therefore, a company may posses effective control at a lower ownership level than legal control.

Are companies required to capitalize interest in assets that are self-constructed?

Yes, apply the interest rate to weighted average accumulated expenditures for qualifying asset during capitalization period

What is depletion?

allocation of cost of a natural resource to the periods in which the benefits are received

What is fair value?

amount at which the asset could be sold in a current transaction between market participants

How are R&D costs expensed?

as incurred

What factors are involved in depreciation?

assets cost, service life, residual value and method of cost allocation

What is asset impairment?

because depreciation is a cost allocation process it does not attempt to measure fair value, but situations may occur in which the future economic benefit or service potential of asset decreases below its book value which is known as an impairment