BUSM Chapter 7

Accounting definition of depreciation

allocation of an asset's cost to an expense over time. We allocate a portion of the assets cost to depreciation expense in each year as the asset provides a benefit. We use the term depreciation to describe that process when it applies to property, plant, and equipment.

Intangible assets

assets that do not have physical substance. Assets in this category include patents, trademarks, copyrights, franchises, and good will.

Trademark

a word, slogan, or symbol that distinctively identifies a company, product, or service. Registered with the U. S. Patent and trademark office to protect it from use by others for a period of 10 years.

Amortization

the process of allocating to expense the cost of an intangible asset

Amortization

the process of allocating to expense the cost of an intangible asset. The service life of an intangible asset usually is limited by legal, regulatory, or contractual provisions. etc. patent length The expected residual value of most intangible assets is 0 unless the asset will benefit another entity at the end of its life Most companies use straight-line amortization and credit amortization to the intangible asset account itself

Patent

(n.) exclusive rights over an invention; copyright; (v.) to arrange or obtain such rights; (adj.) plain, open to view; copyrighted When a firm purchases a patent it records the patent as an intangible asset at its purchase price plus other costs such as legal and filing fees to secure the patent. The U. S. Patent and Trademark Office grants this right for a period of 20 years.

Three different ways assets can be disposed of

1. Sale: most common method to dispose of an asset. When a long-teen asset is no longer useful but cannot be some we have a retirement 2. Retirement 3. Exchange: occurs when two companies trade assets

Three factors of recording depreciation

1. Service life: the estimated use the company expects to receive from the asset before disposing of it 2. Residual value: The amount the company expects to receive from selling an asset at the end of its service life. 3. Depreciation method: The pattern in which the asset's depreciable cost (original cost minus residual value) is allocated over time

Three most common depreciation methods

1. Straight-line: This method allocated an equal amount of depreciation to each year. The implication is that the asset is used evenly over its useful life. Simplest and most common method 2. Declining-balance: An accelerated method, meaning that more depreciation expense is taken in the earlier years than in the later years of an assets life 3. Activity-based: Calculates deprecation based on the activity also associated with the asset. Commonly used to allocate the cost of natural resources.

Two ways companies acquire intangible assets

1. They purchase intangible assets like patents, copyrights, trademarks, or franchise rights from other companies. 2. They develop intangible assets internally for instance by developing a new produce or process and obtaining a protective patent

Expenditures after Acquisition

1. We capitalize an asset if it's increases future benefits 2. We expense an expenditure if it benefits only the current period

Accumulated Depreciation

A contra asset account meaning it reduces an asset account

Copyright

An exclusive right of protection given by the U. S. Copyright office to the creator of a published work such as a song, film, painting, photograph, book, or computer software. Also allows the copyright holder to pursue legal action against anyone who attempts to infringe the copyright.

Material

An item is said to be material if it is large enough to influence a decision. When an expenditure is not material the item is typically recorded as an expense regardless of its expected period of benefit.

Declining Balance Depreciation

Both declining-balance and straight-line will result in the same total depreciation over the asset's service life. The depreciation rate we use under the declining-balance method is a multiple of the straight-line rate. The most common rate is 200% 1. We multiply the rate by book value

Equipment

Equipment is a broad term that includes machinery used in manufacturing, computers and other office equipment etc. The cost of equipment is the actual purchase price plus all other costs necessary to prepare the asset for use.

Land improvements

Improvements to land such as paving, lighting, and landscaping that, unlike land itself, are subject to depreciation

Goodwill

It is recorded only when one company acquired another. Is recorded by the acquiring company for the amount that the purchase price exceeds the fair value of the acquired company's identifiable net assets.

Franchises

Local outlets that pay for the exclusive right to use the franchisor company's name and to sell its products within a specified geographical area

Profit margin

Net income divided by net sales

Asset turnover

Net sales divided by average total assets

Loss

Occurs when we sell an asset for less than its book value. Losses like expenses have a debit balance and are reported as a decrease to net income.

Gain

Occurs when we sell an asset for more than it's book value. Has a credit balance and is reported as an increase to net income

Reporting internally developed intangible assets

Rather than reporting these in the balance sheet as intangible assets we expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs.

Return on assets

Return on assets = Net Income / Average total assets A more comparable measure of profitability than net income

Components of return on assets

Return on assets = profit margin X asset turnover

Depreciable cost

The asset's cost minus its estimated residual value. Depreciation is an estimate Depreciation expense = Asset's cost - Residual value / Service life = Depreciable cost / Service life

Buildings

The cost of acquiring a building usually includes realtor commissions and legal fees in addition to the purchase price.

Improvement

The cost of replacing a major component of an asset. Usually increases future benefits so should be capitalized.

land

The land account represents land a company js using in its operations. We capitalize to land all expenditures necessary to get the land ready for use. Such capitalized costs include the purchase price of land plus closing costs such as fees

When to apply impairment

The two-step impairment process applies to property, plant, and equipment and to intangible assets with finite useful lives. For intangible assets with indefinite useful lives we omit step 1

Sale of Long-Term assets

Typically involves a transaction in which cash is received for the asset given up. The difference between the cash received and the book value of the asset given up is reported as a gain or loss in the income statement.

Activity-based depreciation

We allocate an asset's cost based on its use. Depreciation rate per unit = Depreciable cost / Total units expected to be produced

Natural resources

We can distinguish natural resources from other property, plant, and equipment by the fact that we can physically use up or deplete natural resources.

Repairs and Maintenance

We expense expenditures like these in the period incurred because they maintain a given level of benefits

Reporting Purchased Intangible Assets

We record purchased intangible assets as their original cost plus all other costs such as legal fees necessary to get the asset ready for use.

Addition

When we add a new major component to an existing asset. We should capitalize the cost of addition if they increase, rather than maintain the future benefits from the expenditure.

Intangible assets not subject to amortization

goodwill and trademarks with indefinite life

Impairment

occurs when the expected future cash flows (expected future benefits) generated for a long-term asset fall below its book value (original cost minus accumulated deprecation) Two steps; Step 1: test for impairment: A long-term asset with a finite life is impaired if future cash flows are less than book value Step 2: if impaired, record the loss: the impairment loss is the amount by which book value exceeds fair value

Big bath

recording all losses in one year to make a bad year even worse. management cleans its slate and can record higher earnings in the following years

Long-term asset

property, plant, and equipment category consisting of land, land improvements, buildings, equipment, and natural resources. We record a long-term asset at its cost plus all expenditures necessary to get the asset ready for use.

Basket purchase

purchase of more than one asset at the same time for one purchase price. we allocate the purchase price based on the estimated fair values of each of the individual assets

Capitalize

record an expenditure as an asset. after initially being recorded as an asset, most capitalized expenditures are expenses over time as the asset is used in company operations.

Book value

the difference between the cost of a depreciable asset and its related accumulated depreciation