Ch. 7: Long-Term Assets

Patent

An intangible asset that is an exclusive right to manufacture a product or to use a process. This right is granted for 20 years.

How do we record the sale of a long-term asset?

1) Recorded as a gain if sold for more than book value (credit balance account like all other revenue accounts) 2) Recorded as loss if sold for less than book value (debit balance account like all other expense accounts) -Both are recorded on the income statement as nonoperating revenues and expenses

What are 3 ways an asset can be disposed of?

1) Sale-most common method 2) Retirement-used when a long-term asset is no longer useful but cannot be sold. 3) Exchange-two companies trade assets. In exchanges, cash is often used to make up for any difference b/w fair value of the assets.

How does a firm record advertising costs when it develops a trademark internally through advertising?

A firm will expense the advertising costs in the income statement

Declining-balance method

Accelerated depreciation method. Declining-balance depreciation will be higher than straight-line depreciation in earlier years, but lower in later years.

How does an asset's material worth influence whether costs associated with it are recorded as assets or expenses?

Companies generally expense all costs under a certain dollar amount regardless of whether future benefits are increased.

Improvement

The cost of replacing a major component of an asset.

What is the expected residual value of most intangible assets?

0

How do we determine the depreciation rate used under the straight-line depreciation method?

1/service life

What amortization method do most companies use for intangible assets?

Straight-line amortization.

Residual/salvage value

The amount a company expects to receive from selling an asset at the end of its service life. It's not uncommon to assume a residual value of 0.

What does return on assets indicate?

The amount of net income generated for each dollar invested in assets. Higher return on assets=more effective use of assets.

How should we record the cost of improvements?

The cost of improvement usually increases future benefits and we should capitalize it to the Equipment account.

How do we calculate the average depreciation rate per unit for the activity-based method?

Depreciable cost (cost - residual value)/ number of units expected to be produced

How do we record annual depreciation?

Debit Depreciation Expense Credit Accumulated Depreciation (contra-asset).

Depreciable cost

(Asset's cost-residual value)/service life. Represents total depreciation to be taken over the asset's useful life.

How do we record a change in estimate of an asset's service life or residual value?

(Take the asset's book value at the end of the year before the estimate is changed-new residual value)/new remaining service life. Do not go back and change calculations for previous years.

What are land improvements and how do we record them?

-Any additional amounts spent to improve the land in any way, such as adding sidewalks, parking lot, landscaping etc. -They are recorded separately from land itself

What is the dictionary definition of depreciation in comparison to the accounting definition of depreciation?

-Dictionary: Decrease in value (or selling price) of an asset -Accounting: The allocation of an asset's cost to expenses over time. *Long-term assets are recorded at their cost, and this cost is allocated as an expense over time.

When and how is Goodwill recorded?

-It is recorded only when a company acquires another company. -It 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 (assets-liabilities).

What do we call the process of the cost of a long-term asset being allocated as an expense for tangible and intangible assets?

-Tangible: Depreciation -Intangible: Amortization

How would we record a basket purchase of land, building, and equipment for $900,000?

-We need to record land, building, and equipment in separate accounts -Create estimated fair values for each asset -Total the values and then divide each asset's estimated fair value by the total in order to determine the percentage -Multiply each percentage by actual purchase price and record that amount in each account respectively

What are some costs we capitalize to Land?

-land purchase price -closing costs: attorney fees, real estate agent commissions, title, title search, recording fees -clearing, filling, leveling land -removing existing buildings from land to prepare it for use -back taxes or other obligations *If we receive any cash from selling salvaged building materials, we reduce the cost of the land by that amount.

How can companies increase their return on assets/profitability?

1) Increase profit margin -product differentiation -premium pricing -higher selling prices=more profit per dollar of sales 2) Increase asset turnover -charging lower prices=increase in sales volume=more sales per dollar invested in assets

What 2 business strategies comprise return on assets?

1) Profit Margin: (Net income/ net sales) ~multiplied by~ 2) Asset turnover: (Net sales/ average total assets)

When we make an expenditure, what are our two choices for recording it?

1) Record it as an expense of the current period 2) Record it as an asset and then allocate that cost as an expense over future periods. *Depends on when company benefits from having asset.

Name and define the 3 most common depreciation methods?

1) Straight-line: A method which takes an equal amount of depreciation each year. Most common method of financial accounting. 2) Declining balance: Accelerated method, meaning that more depreciation expense is taken in the early years than in the later years of an asset's life. 3) Activity-based: Method that calculates depreciation based on the use of an asset. Commonly used to allocate cost of natural resources. *No matter what method we use, total depreciation over the asset's service life will be equal to the depreciable cost (asset cost-residual value)

What are two ways companies can acquire intangible assets?

1) They can purchase intangible assets from other companies 2) They can develop intangible assets internally, for instance by developing a new product or process and obtaining a protective patent *Recording rules vary based on how the asset was obtained

What are 2 unusual features of declining balance depreciation?

1) We multiply the rate of depreciation by the book value (cost-accumulated depreciation), not by the depreciable cost (cost-residual life) 2) The depreciation expense in the final year is the amount that reduces the book value to the estimated residual value.

Basket purchase

A purchase in which a company purchases more than one asset at the same time for one purchase price.

Capitalize

A term that describes recording an expenditure as an asset.

What is the advantage of using accelerated depreciation methods in comparison to straight-line?

Accelerated methods reduce taxable income more in the earlier years of an asset's life than does straight-line. Most companies use straight-line depreciation for financial reporting and an accelerated method called MACRS for tax reporting.

Depreciation

Allocating the cost of an asset to an expense over its service life. Does not refer to change in value or selling price.

Amortization

Allocating the cost of intangible assets to expense.

Copyright

An intangible asset that is 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.

Trademark

An intangible asset with an indefinite useful life that is a word, slogan, or symbol that distinctively identifies a company, product, or service. Often acquired through acquisition.

Material

An item is said to be material if it is large enough to influence a decision.

What does the cost of constructing a building include?

Architect fees, material costs, construction labor, manager supervision, overhead, interest costs incurred during construction

How does a firm record internal development of a patent?

As an operating expense in the income statement WITH THE EXCEPTION OF LEGAL FEES. No matter how a patent was obtained, firm will record legal and filing fees used to secure the patent in the Patent asset account.

Intangible Assets

Assets that have no physical substance

What can a firm record as an intangible asset in the Trademark asset account?

Attorney fees, registration fees, design costs, successful legal defense, and other costs directly related to securing the trademark.

What do assets provide?

Benefits (revenues)

What is Goodwill and how is it calculated?

Benefits not identified as assets. Purchase price-company's identifiable net assets. PS Goodwill increases by debit.

Activity-based method (Units of production/ Units of Output)

Depreciation method in which we allocate an asset's cost based on its use, not based on time.

Straight-line method

Depreciation method in which we allocate an equal amount of the depreciable cost to each year of the asset's service life. Assumes that the benefits we derive from the use of an asset are the same each year.

What equation is used to determine the depreciation rate for double-declining balance depreciation?

Double-declining balance depreciation rate= 2/estimated service life.

True or False: The estimated value of a trademark is recorded in the Trademark's account along with the cost of advertising.

False! The estimated value of a trademark is not recorded in the Trademarks account (only the legal, registration, and design fees are recorded) and the advertising costs that help create value for the trademark are recorded as advertising expense.

Accelerated depreciation method

Higher depreciation in the earlier years of an asset's life and lower depreciation in later years. Assumes that the asset will provide greater benefits in the earlier years of its life than in the later.

Service/useful life

How long the company expects to receive benefits from an asset before disposing of it. Recording depreciation requires accountants to estimate the service life of an asset, as well as its residual value at the end of that life.

How should a firm record the cost of legal defense of intangible assets of an asset they acquired previously?

If a firm successfully defends an intangible right, it should capitalize the litigation costs. However, if the defense of an intangible right is unsuccessful, the firm should expense the litigation costs as incurred because they provide no future benefit.

How does a company record the internal generation of goodwill?

In the same fashion as other internally-generated intangible assets; a company must expense costs incurred in the internal generation of goodwill.

How do we record purchased intangible assets?

In the same way we record tangible assets, we record purchased intangible assets at their original cost plus all other costs, such as legal fees, necessary to get the asset ready for use.

What is another name for tangible assets and what does this category account for?

Property, plant, and equipment. Accounts for land, land improvements, buildings, equipment, and natural resources.

Franchises

Intangible assets that are 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.

How is depreciation recorded for land?

It's not because land is not "used up" over time/its service life never ends.

What are some common expenditures made after the acquisition of a long-term asset.

Maintenance and repair, additions, improvements, legal defense of intangible assets, and materiality.

How do most companies record amortization?

Many companies credit amortization to the intangible asset account itself rather than to accumulated amortization.

How can we distinguish natural resources from other property, plant, and equipment?

Natural resources can be depleted/used up

What are some examples of intangible assets?

Patents, *trademarks (brand), copyrights, franchises, and goodwill

How do we calculate the depreciation expense during the reporting period of an asset under the activity-based method?

Per unit rate x Number of units of activity each period.

What does the cost of equipment include?

Purchase price + all other costs necessary to prepare asset for use, such as sales tax, shipping, delivery insurance, assembly, installation, testing, & legal fees incurred to establish title

What does the cost of acquiring a building include?

Purchase price + realtor commissions + legal fees

How do we record intangible assets that are developed internally?

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.

How do we record recurring costs related to equipment, such as annual property insurance or annual property taxes?

Record recurring costs as an expense of the current period when we incur them. Ask yourself: "Is this a cost of acquiring the asset and preparing it for use? Or is this a recurring cost that benefits the company in the current period?"

What is the general rule for recording long-term assets?

Record the asset at its cost + all expenditures necessary to get asset ready for use (Initial cost of long-term asset may be more than its purchase price; will include any additional amounts firm paid to bring asset to desired location and condition for use)

How does a firm record the purchase of a patent?

Record the patent as an intangible asset at its purchase price plus other costs such as legal and filing fees to secure the patent.

What is a more comparable measure of profitability between companies than income?

Return on Assets (ROA): net income/average total assets (beginning+ending amount/2)

What is an advantage of using the straight-line depreciation method in comparison to accelerated methods?

Straight-line produces a higher net income than accelerated methods in the earlier years on an asset's life. Most companies use straight-line depreciation for financial reporting and an accelerated method called MACRS for tax reporting.

How are tangible assets recorded?

Tangible assets such as land, land improvements, buildings, equipment, and natural resources are recorded at cost plus all costs necessary to get the asset ready for its intended use.

What depreciation rate do we use under the declining-balance method? What is the most common rate?

The depreciation rate used with the declining-balance method is a multiple of the straight-line rate (125%, 150%, 200%). Most common rate is 200% known as the double-declining balance method.

How does a franchisee record the cost of a franchise?

The franchisee records the initial fee as an intangible asset. Additional periodic payments to the franchisor are typically for services that the franchisor provides on a continuing basis and the franchisee will expense them as incurred.

Book value (carrying value)

The original cost of the asset minus the current balance in Accumulated Depreciation

How are advertising costs reported?

They are recorded as an expense and reported in the income statement at the time they are incurred, not as an intangible asset in the balance sheet.

How can companies internally generate goodwill?

To some extent through advertising, training and other assets.

How do we capitalize additional expenditures after the acquisition of a long-term asset?

We capitalize an expenditure as an asset if it increases future benefits and as an expense if it benefits only the current period.

Which intangible assets do we not amortize?

We do not amortize intangible assets with an indefinite (unknown or not determinable) useful lives. An asset's useful life is indefinite if there is no foreseeable limit on the period of time over which we expect it to contribute to the cash flows of the entity. Ex. Goodwill & trademarks (w/ indefinite lives)

How would we record the cost of an engine tune-up or repair of an engine part for a delivery truck?

We expense repair and maintenance expenditure such as these in the period incurred because they allow the truck to continue its productive activity and maintain a given level of benefits.

How should we record the cost of additions?

We should capitalize the cost of additions if they increase, rather than maintain, the future benefits from the expenditure.

How would we record the cost of a new transmission or an engine overhaul for a delivery truck?

We would record this type of extensive repair as an asset because it increases the future benefits of the delivery truck.

Addition

When a new major component is added to an existing asset.