ACCT 2110 Chapter 7

Most common depreciation methods

-Straight-line -Most common -Declining balance -Units-of-production

Straight-line rate

1/useful life

Depreciable cost

Depreciable cost is calculated as the cost of the asset less its residual (or salvage) value -This amount will be depreciated (expensed) over the asset's useful life

Voluntary disposal

A type of disposal that occurs when a 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

Involuntary disposal

A type of disposal that occurs when assets are lost or destroyed through theft, acts of nature, or by accident

Capital expenditures

Expenditures to acquire long-term assets or extend the life, expand the productive capacity, increase the efficiency, or improve the quality of existing long-term assets -Are added to the asset account and are subject to depreciation -Extraordinary or major repairs, additions, remodeling of buildings, and improvements (betterments)

Management should select the method that

Best matches the pattern of decline in service potential of the asset

Modified Accelerated Cost Recovery System (MACRS)

Most companies use MACRS to compute depreciation expense for their tax returns, which is similar to the declining balance method -MACRS is not acceptable for financial reporting purposes

Natural resources

Naturally occurring materials that have economic value -Timberlands and deposits such as coal, oil, and gravel

Do most intangible assets have a residual value?

No

Does deprecation on tax returns fall under the matching principle?

No

Does land improvements, buildings, and equipment have an unlimited life?

No -Limited -Subject to depreciation

Are intangible assets with an infinite life subject to amortization?

No, but should be reviewed annually for impairment

Amortization expense is reported as an

Operating expense on the income statement

Organizational costs

Significant costs such as legal fees, stock issue costs, accounting fees, and promotional fees that a company may incur when it is formed -Must be recorded as an expense in the period the cost is incurred

Residual value

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

Depreciation expense

The amount of depreciation recorded on the income statement

The declining balance depreciation method accelerates

The assignment of an asset's cost to depreciation expense by allocating a larger amount of cost to the early years of an asset's life -This is consistent with a decreasing rate of decline in service potential and a decreasing amount for depreciation expense

As the inventory is sold

The company will recognize an expense (cost of goods sold) related to the natural resource

Research and development (R&D) expense

The cost of internal development of intangible assets that is expensed as incurred -R&D is not an intangible asset -Must be recorded as an expense

Fixed asset turnover ratio

The more efficiently a company uses its fixed assets, the higher the ratio will be

Declining balance depreciation method

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 -Declining balance depreciation expense for each period of an asset's useful life equals the declining balance rate times the asset's book value (cost less accumulated depreciation) at the beginning of the period

Depreciation is not

An attempt to accumulate cash for the replacement of an asset

Cost

Any expenditure necessary to acquire the asset and to prepare the asset for use

Disposal requires two journal entries

1. An entry to record depreciation expense up to the date of disposal. 2A. Remove the asset's book value (the cost of the asset and the related accumulated depreciation) or 2B. 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

The following information is necessary in order to measure depreciation

1. Cost of the fixed asset 2. Useful life (or expected life) of the fixed asset 3. Residual value (salvage value) of the fixed asset

Impairment test

1. Existence: an impairment exists if the future cash flows expected to be generated by the asset are less than the asset's book value 2. Measurement: if an impairment exists, the impairment loss is measured as the difference between the book value and the fair value of the asset

How to revise a depreciation expense

1. Obtain the book value of the asset at the date of the revision of depreciation 2. Compute depreciation expense using the revised amounts for book value, useful life, and/or residual value

The historical cost principle requires that

A company record its fixed assets at the exchange price at the time the asset is purchased. When cash is paid in exchange for an asset, the amount of cash given, plus any other expenditure necessary to prepare the asset for use, becomes part of the historical cost of the acquired asset

Straight-line depreciation method

A depreciation method that allocates an equal amount of an asset's cost to depreciation expense for each year of the asset's useful life -Straight-line depreciation expense for each period is calculated by dividing the depreciable cost of an asset by the asset's useful life

Units-of-production depreciation method

A depreciation method that allocates the cost of an asset over its expected life in direct proportion to the actual use of the asset -Depreciation expense is computed by multiplying an asset's depreciable cost by a usage ratio

The units-of-production depreciation method is based on

A measure of the asset's use in each period, and the periodic depreciation expense rises and falls with the asset's use -This method is based not on a standardized pattern of declining service potential but on a pattern tailored to the individual asset and its use

Impairment

A permanent decline in the future benefit or service potential of an asset

What deperecation methods are accepted by the GAAP?

All three

Property, plant, and equipment

Assets that can be seen and touched -Land, buildings, machines, and automobiles -Fixed assets

Intangible operating assets

Assets that provide a benefit to a company over a number of years but lack physical substance -Patents, copyrights, trademarks, and good will

Equipment

Assets used in operations -Machinery, furniture, automobiles

The straight-line depreciation method produces a

Constant amount of depreciation expense in each period of the asset's life and is consistent with a constant rate of decline in service potential

Depreciation is a

Cost allocation process

If m=2

Double declining balance depreciation method

Revenue expenditures

Expenditures that do not increase the future economic benefits of the asset -Are expensed as they are incurred -Maintenance and repair of an asset

Operating assets represent

Future economic benefits, or service potential, that will be used in the normal course of operations

Intangible assets

Generally result from legal and contractual rights -Patents, copyrights, trademarks, licenses, and goodwill

Operating assets

Long-lived assets that are used by the company in the normal course of operations

Natural resources

Resources, such as coal deposits, oil reserves, and mineral deposits, that are *physically consumed* as they are used by a company and that can generally be replaced or restored *only by an act of nature*

Land Improvements

Structural additions or improvements to land -Such as driveways, parking lots, fences, landscaping, lighting

Buildings

Structures used in operations -Factory, office, warehouse

The Internal Revenue Code specifies which depreciation method a company should use to prepare

Tax returns -Does not have to be the same method as the balance sheet

Useful life

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

Depletion

The process of allocating the cost of a natural resource to each period in which the resource is removed from the earth

Depreciation

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

Amortization

The process whereby companies systematically allocate the cost of their intangible operating assets as an expense among the accounting periods in which the asset is used and the benefits are received -*Finite* life

Land

The site of a manufacturing facility or office building used in operations

Depreciation methods

The standardized calculations required to determine periodic depreciation expenses

Accumulated depreciation

The total amount of depreciation expense that has been recorded for an asset since the asset was acquired -Reported on the balance sheet as a contra-asset

Book value

The value of an asset or a liability as it appears on the balance sheet -Calculated as the cost of the asset or liability minus the balance in its related contra account -"Carrying value"

Does land have an unlimited life?

Yes -Not subject to depreciation