accounting chapter 8 long-term assets
key take aways
-PPE and purchased intangible assets are assets that we capitalize because they will generate future benefits -we include all costs in the acquisition value needed to put the asset in use -We use the MATCHING PRINCIPLE to account for depreciation or amortization expense on the income statement and reduce the value of the asset on the balance sheet by crediting accumulated depreciation for PPE (tangible assets) or the asset account directly for intangible assets -When we sell assets, we have to remove the assets and the accumulated depreciation from the books. Sales often results in gains and losses. -Long-term assets need to be periodically checked for impairment. -Intangible Assets can be amortized (e.g., patents) or impaired (e.g., trademarks, goodwill).
Impairment Test
1. Estimate the anticipated future undiscounted cash flows (undiscounted P.V.) • Estimating future cash flows requires significant assumptions about demand, growth rates, etc. 2. Compare your undiscounted cash flows (undiscounted present value) to the net book value (book value / carrying value) of the asset. 3. DECISION POINT: If the net book value exceeds the undiscounted present value, the manager needs to write-down (impair) the asset. NBV> cash flow value= impairment 4. CALCULATION OF IMPAIRMENT COST: Don't write down to the undiscounted present value. Instead, write down to the fair market value (FMV). Impairment Loss = Net Book value (NBV) - Fair Market Value (FMV) • Need to estimate fair market value if there is no liquid market selling price for similar assets. We use models that require assumptions to do so. If fair value cannot be reliably estimated, we write down to the discounted cash flow. • Going forward, depreciate the new fair market value (new NBV) of the asset over the remaining expected useful life.
accounting for the sale of long-term assets
1. Sale of asset requires that its historical cost and accumulated depreciation be removed from books 2. Sale transaction also requires recognition of proceeds 3. Difference between sale proceeds and net book value of asset being sold results in a gain or loss on sale
PPE can be capitalized when
1. The asset is owned or controlled by the company 2. The asset is expected to provide future benefits that are measurable 3. Measurable Costs 4. From past transaction or event • Determining the costs to capitalize requires judgment (should be directly linked to future benefits) • Capitalized amount should not exceed the expected future benefit
Calculate net book value of asset after few years:
1. calculate annual depreication expense Annual depreciation expense= (puchase price-salvage value)/estimated useful life 2. AD x years of posetion 3. Orginal cost - accumulated depreciation = NBV
depreciation methods
1. straight-line depreciation - Allocates the cost of asset to future periods equally across useful life - Used by an overwhelming majority of US firms 2. Accelerated Depreciation: (e.g., Declining Balance) - Higher depreciation expense is recognized in the earlier years of an asset's useful life - Mostly used for tax reporting, but can also be used for financial reporting (can use different methods for each type of reporting) 3. Units of Activity (Units of Production) - Allocates the cost of long-term asset to future periods based on its activity (e.g., estimated hours of use, number of units produced, number of miles driven) - Frequently used in mining, oil and gas industries (depletion)
to account for depreciation must know
1. what is the expected useful service life 2. what is the salvage value 3. what pattern of depreciation should be used to allocate cost over useful service life
undiscounted projected cash flows from the asset
= (net cash flow per year x years remaining inusful life) + salvage value
double-declining balance depreciation method
Accelerated method --> greater amounts of depreciation in early years of asset's life Depreciation for a period = NBV x Depreciation Rate Net Book Value* = Acquisition Cost - Accumulated Depreciation Depreciation Rate= (2** x (1 / Useful Life in Years)) Salvage value is not used in base calculation (Salvage value will be considered later in the depreciation process) *Note that net book value is different than "depreciable base." Salvage value is included in net book value, but not depreciable base. **"2" is used in the "Double-Declining Balance" method. Other rates, such as "1.5" could also be used for other "declining balance" methods.
aquired intangibles: NOT GOOD WILL
Acquired intangibles with a limited life are recorded at historical cost and amortized over the USEFUL life amortized over ECONOMIC LIFE not the LEGAL LIFE of the asset
straight-line depreciation method
Allocates the cost of asset to future periods equally across useful life • Used by overwhelming majority of US companies Depreciation Expense Per Period = [Acquisition Cost - Salvage Value] / Useful Life Depreciable Base = [Acquisition Cost] - [Salvage Value] Depreciation rate per period= 1 / Useful Life
units of activity depreciation method
Allocates the cost of long-term asset to future periods based on its activity (estimated hours of use, number of units produced, number of miles driven) Frequently used in mining, oil and gas industries, but also other situations where activity best represents the consumption of asset benefits (e.g. vehicles) Depreciable base = Acquisition cost - Salvage value Depreciation rate= (Acquisition cost - Salvage value)/Total estimated activity units
Depreciable Base (DB)
Depreciable Base = Acquisition cost - Salvage Value Depreciable Base = Portion of the cost that is depreciated
cost allocation: depreciation
Depreciation is a process: - That allocates acquisition costs of PP&E over their productive lives as an expense to periods that benefit from the asset • Systematic Method • Rational Method - relates to the pattern of benefits - depreciation is NOT a process of determining market value or worth
self-constructed assets capitalized cost
Direct costs of construction: materials, labor, and some amount of overhead Construction financing: Any interest cost on money borrowed directly attributable to financing the construction, i.e., interest costs are capitalized
amortization of acquired intangibles (R)
Dr. Amortization Expense for Intangible Asset (SE) $XXX Cr. Intangible Assets (A) $XXX amount = (Cost / Useful Life), if straight-line approach is used dont usually have a salvage value. think of a patient for cutting edge tecnology. usless when something better comes out
accounting for PP&E during use (R)
Dr. Depreciation Expense (SE) Cr. Accumulated Depreciation (XA)
depreciation expense (R)
Dr. Depreciation Expense (SE) Cr. Accumulated Depreciation (Equip.) (XA)
imparment loss (R)
Dr. Loss on Impairment of Equipment (SE) Cr. Accumulated Depreciation— Equip.(XA)
self-constructed assets (R)
Dr. PP&E (A) amount added to BS to pay for construction Cr. Cash (A) (or materials, etc.)
goodwill journal entry (R)
Dr. Total Identified Assets(A) $70 Dr. Goodwill (A) $60 Cr. Total Identified Liabilities (L) $30 Cr. Cash (or Stock) $100
Asset impairments
GAAP requires that long-term assets must be at the lower of the book value and market value. Firms may need to conduct periodic impairment tests to see if the market value is below the cost value.
goodwill caluculation
Goodwill is the difference between the price paid for a business and the fair value of the acquired business's net assets. (Goodwill can only arise from an acquisition) Goodwill = Acq. Price - FV of net assets FV of net assets= FV of identifiable assets - FV of idnetifable liablities
Presentation on Income Statement for Disposition of Assets
On the Income Statement, have a "gain on disposition" or "loss on disposition" line item within the Income Statement if the amount is significant.
accounting for PP&E during use
PP&E is an asset that will generate future benefits (revenues). • Matching principle: Recognize expenses during the periods when the related revenues (benefits) are recognized. • We recognize depreciation expense (income statement) during the periods that future benefits are recognized. • Since we are using up the asset, we increase expenses and reduce the asset value. • We do not depreciate land!! (indefinite life asset)
PPE on the BS
PPE, at cost less: accumulated depreciation PPE net
terms used for allocation
PPE=depreciation intanageble assets= amortization
purchased assets capitalized cost
Purchase price plus all costs to prepare asset for initial use - Invoice price (less discount), freight, installation, legal fees, taxes, etc.
Determining the Salvage Value (SV)
Requires managerial judgment • Salvage Value = estimated proceeds at disposal, net of selling costs
Determining the Useful Service Life (UL)
Requires managerial judgment • The time period over which the asset will be used by the company • Might not equal the physical life of the asset
amortization of acquired intangibles
Straight-line method is the most common approach. • Based on economic life, which can be much shorter than legal life.
when should we test for impairment?
Testing each asset each period would be too costly, so instead Managers (and auditors/analysts) pay attention to changes in circumstances that might indicate carrying values are too high: - A change in the way an asset is used or a physical change in an asset - Adverse changes in legal factors or business climate - Accumulated costs in excess of amounts originally expected to construct or acquire the asset - A change in industry conditions/macro econ. factors
Long-term assets
They have long lives ---> means they provide benefits for many years. cost of a long-term asset should be spread over its useful life to match with the revenue it generates (matching principle)
double-declining balance deprecation method problem
Under the DD Balance method, if we use the same formula to calculate depreciation expense in the later period(s) (net book value * depreciation rate), we frequently end with a net book value (NBV) below the salvage value (we depreciate too much!) To overcome this, in the period when the formula would cause accumulated depreciation to cause the NBV to decline below the depreciable base, we instead use a plug value to get NBV down to exactly the salvage value Plug value acts as that periods depreciation rate plug value= NBV at begging of that year - NV at end of the year (which is salvage value)
when to capitalize and when to expense
capitalization: recording of an expenditure as an asset on the balance sheet when an expendature event (spending) occurs ask "are the four requirments met?" (measurable cost, controlled by entity, future benifits measurable, from past transaction or event?) if yes: capitalize (record as an asset) if no: expense immediately
capitalizing vs. expensing
capitalizing means the expendaiture is recorded in the CURRENT period as an ASSET on the B/S instead of as an expense on Income Statement when LT are acquired, the cost is either initially capitalized or expensed -capitalise (asset on BS) -expense immediately (expense on IS): do this when 1. benifits are immediate or 2. future benifits are too uncertain or immaterial
changes in depreciation estimates
caused by changes in usful life, salvage values, Net book value (resulting from an asset modification or write down) apply changes PROSPECTIVELY change assumptions impact FUTURE PERIODS ONLY do not re-state any prior periods statments
Intangible Assets: Indefinite Lives
examples inclue trademarks, trade names, goodwill expenses with subjigation to annual imparment test (definite life intangables are also tested for impairment)
goodwill
excess of amount paid for a business above the fair value of net assets.
How do we account for the "used up" portion of intangibles?
for intangable asssets with DEFINED useful lives we allocate the cost over its useful life. called amortization. ex. patients and copyrights
which cost should be capitalized
include all cost to bring the asset into a usable condition (the cost that provide future benifits
need to record impairment if:
net book value is greater then projected cash flows of asset
intangible assets
non-financial assets without physical substance that consist of contractual rights, legal rights, or other economic benefits. examples include: patients, copyrights, trademarks and goodwill
net book value
purchase value - depreciation expense
depreciable base
purchase value - salvage value
sale of PPE after depreciation (R)
record depreciation expense of having it in your posesion for X number of years AND then sale gain on sale: dr. cash (A)- amount recived from sale dr. accumulated depreciateion (XA)- amount of depreciation inccured cr. PPE (A)- NBV of orginal purchase of iteam cr. Gain on sale (SE)- amount of gain on sale Loss on sale: dr. cash (A)- amount recived from sale dr. accumulated depreciateion (XA)- amount of depreciation inccured dr. loss on sale (SE)- amount of lost on sale cr. PPE (A)- NBV of orginal purchase of iteam
amortization
spreading an intangible assets cost over that assets useful life basically the depreciation expense but for intangible assets not physical assets
types of LTA
tangible assets- have physical existence (ex. PP&E, natural resoucres, ect.) intangable assets- confer rights, privilages and benifits to owners (ex. patents, copyrights, trademarkes, brand names, good will, ect.)
what is included in aquasition cost of intangable assets?
the cost of intangible assets purchased from an third-party is capitalized ("arms length transaction") HOWEVER, we DONT capitalize the cost of INTERNALLY DEVELOPED intangable assers this is because the amount of future benifits are too uncertain
gross book value
value of the asset excluding the impact of accumulated depreciation
purchased PPE and maintenance cost (R)
we include expenses to prepare property for initial use at the same time and included in the intial payment date purchased: dr. PPE (A) cr. cash (A) maintenance isnt generally required to prepaire an asset for its initial use so it isnt included in capitalized asset value but instead expensed in period inccured period with maintenance: dr. maintance expense (SE) cr. cash (A)
Net Book Value (NBV) or Book Value (BV)
when an asset is depreciated, the remaining net asset value on the BS is the NBV and NOT the current market value
improvments (R)
when you make an improvement you add the improvement expenditure to the gross value of an asset date purchased: dr. PPE (A) cr. cash (A) date of improvement: dr. PPE (A) amount of improvent value cr. Cash (A) amount of improvment expense
how to calculate imparment loss
write-down= NBV-Fair market value
Disposition of Assets
• Accounts Affected by Disposition of Assets 1. Credit PP&E (A) to remove the asset 2. Debit Accumulated Depreciation (XA) to remove the depreciation associated with the asset 3. Debit Cash to record receipt of cash 4. Debit Loss/Credit Gains on Disposition of Assets
expensing capitalized LTA
• Capitalized costs for long-term assets are usually expensed over time. - Tangible Assets (e.g., PPE)--> Depreciation - Intangible Assets (e.g., Patent)--> Amortization - Exception!: Unlimited life assets--> NOT systematically expensed (e.g., land) -however they are periodically reviewed for possible write-downs
intangible asset key take aways
• Intangible asset lack physical substance and provide economic benefits. • Generally, costs of internally developed intangibles are expensed while purchased intangible costs are capitalized. • Goodwill is the difference between the price paid for a business and the fair value of the acquired business's net assets. • Limited life intangibles are amortized while all intangibles are subject to impairment tests