Chapter 7 Operating Assets
Straight-line depreciation
(cost - residual value) / Expected useful life
Depreciation cost per unit
(cost - residual value) / expected usage of the asset
Declining balance rate
(m) X straight-line rate (which is 1 / useful life)
Straight-line rate
1 / useful life
The disposal of property, plant, and equipment requires two journal entries:
1. an entry to record depreciation expense up to the date of disposal. 2. an entry to: remove the asset's book value (the cost of the asset and the related accumulated depreciation) 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.
Amortization for intangible assets
As the service potential of an operating asset declines, the cost of the asset is allocated as an expense among the accounting periods in which the asset is used and benefits are received (the expense recognition, or matching, principle).
Depletion for natural resources
As the service potential of an operating asset declines, the cost of the asset is allocated as an expense among the accounting periods in which the asset is used and benefits are received (the expense recognition, or matching, principle).
Depreciation for property, plant, and equipment
As the service potential of an operating asset declines, the cost of the asset is allocated as an expense among the accounting periods in which the asset is used and benefits are received (the expense recognition, or matching, principle).
Operating assets are divided into three categories:
Property, plant, and equipment (PP&E), intangible assets, and natural resources.
The historical cost principle requires that
a company records its fixed assets at the exchange price at the time the asset is purchased.
Average age of fixed assets =
accumulated depreciation / depreciation expense
Book Value
accumulated depreciation is deducted from the cost of the asset
Capitalized
added to an asset account
The straight-line method
allocates an equal amount of an asset's cost to depreciation expense for each year of the asset's useful life (most used one)
At acquisition
an operating asset is recorded at its costs, including the cost of acquiring the asset and the cost of preparing the asset for use (historical principle).
Natural resources
are naturally occurring materials that have economic value. They include timberlands and deposits such as coal, oil, and gravel.
Depletion
as a natural resource is removed from the earth, the cost of the natural resource is allocated to each unit if natural resource removed.
Equipment
assets used in operations (machinery, furniture, automobiles).
Depletion rate =
cost - residual value / recoverable units
Components of depreciation expense
cost - residual value = depreciable cost /useful life
Book value is equal to
cost minus accumulated depreciation
Is necessary to measure depreciation:
cost of the fixed asset, useful life (or expected life) of the fixed asset, residual value (salvage value) of the fixed asset.
Declining balance depreciation expense
declining balance rate X book value
Depletion =
depletion rate X units recovered (will debit the depletion value as an inventory and credit accumulated depletion).
Units-of-production depreciation expense
depreciation cost per unit X actual usage of the asset
The impairment test consists of two steps:
existence: an impairment exists if the future cash flows expected to be generated by the asset are less than the asset's book value. measurement: if an impairment exists, the impairment loss is measured as the difference between the book value and the fair value of the asset.
Expensed
expenditures that are NOT included as part of the cost of the asset (expensed immediately).
Capitalized
expenditures that are include as part of the cost of the asset
Revenue expenditures
expenditures that do not increase the future economic benefits of the asset and expensed in the same period the expenditure is made.
Extraordinary or major repairs additions
expenditures that extend the asset's useful life ( overhaul or rebuilding of an engine, fixing structural damage to a building)/ adding a new or major component to an existing asset (adding a new wing to a building, installing a pollution-control device on a machine.- accounting treatment( capitalize and depreciate over the asset's remaining useful life/ capitalize and depreciate over the shorter of the remaining life of the asset or the addition).
Capital expenditures
expenditures that extend the life of the asset, expand the productive capacity, increase efficiency, or improve the quality of the product. (added to an asset account and are subject to depreciation).
Ordinary repairs and maintenance
expenditures that keep an asset in normal operating condition- examples (oil change for a truck, painting of a building, replacement of a minor part, normal cleaning cost)- accounting treatment (expense in the current period).
An impairment
is a permanent decline in the future benefit or service potential of an asset.
Declining balance method
is 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.
The cost of a fixed asset
is any expenditure necessary to acquire the asset and to prepare the asset for use.
Accumulated depreciation
is reported on the balance sheet as a contra-asset.
Depreciation
is reported on the income statement.
The residual life (also called salvage value)
is the amount of cash or trade-in consideration that the company expects to receive when an asset is retired from service.
The useful life of an asset
is the period of time over which the company anticipates deriving benefit from the use of the asset.
Depreciation (land are not depreciated)
is the process of allocating, in a systematic and rational manner, the cost of tangible fixed asset (other than land) to expense over the asset's useful life.
Property, plant, and equipment includes:
land, land improvements, buildings, and equipment.
Intangible operating assets
like the tangible assets, represents future economic benefit to the company, but unlike tangible assets, they lack physical substance. (patents, copyrights, trademark, leaseholds, organization costs, franchises, and goodwill.
Fixed asset turnover ratio =
net sales / average net fixed assets ( the more efficiently a company uses its fixed assets, the higher the ratio will be).
Involuntary disposal
occurs when assets are lost or destroyed through theft, acts of nature, or by accident.
Voluntary disposal
occurs when the 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. For example, obsolescence due to unforeseen technological developments may lead to an earlier than expected disposition of the asset.
Property, plant, and equipment (PP&E)
often called fixed assets or plant assets, are tangible operating assets that can be seen and touched. They include, among other things, land, buildings, machines, and automobiles.
Types of expenditures
ordinary repairs and maintenance, extraordinary or majors repairs additions, and improvements ( or betterments).
Building cost includes:
purchase price, closing costs, architectural fees, cost of building permits, excavation costs, remodeling fees.
Land cost includes:
purchase price, real state commissions, delinquent property taxes, closing costs (attorney, title, and survey fees), clearing and grading costs, demolition of unwanted buildings, minus salvage.
Land improvements cost includes:
purchase price, sales taxes, installation cost.
Equipment cost includes:
purchase price, sales taxes, transportation costs, insurance during transportation, installation costs, cost of trial runs.
Expensed
reported in total on the income statement
Accumulated Depreciation
should be equal to the depreciable cost at the end
Book Value
should be equal to the residual value at the end
Depreciation Methods
straight-line, declining balance, units-of-production (the total amount of depreciation expense that has been recorded -accumulated depreciation- over the life of the asset will never exceed the depreciable cost -cost minus residual value- of the asset.
Land improvements
structural additions or improvements to land (such as driveways, parking lots, fences, landscaping, lighting).
Buildings
structures used in operations (factory, office, warehouse).
Natural resources
such as coal deposits, oil reserves and mineral deposits, make up important part of the operating assets for many companies.
Amortization
the cost of an intangible asset with a finite life, like the cost of a tangible asset, is allocated to accounting periods over the life of the asset to reflect the decline in service potential (indefinite life it is not amortized but is reviewed as least annually for impairment).
Operating assets are
the long-lived assets that are used by the company in the normal course of operations. Unlike inventory, operating assets are not sold to customers. Instead, operating assets are used by a company in the normal course of operations to generate revenue.
Improvements (or betterments)
the replacement of a component of an asset with a better one that increases efficiency or productivity - examples (replacing an old air conditioning unit with a more efficient one, replacing a manual machine control with computer- controlled controls) - accounting treatment( capitalized and depreciate over the improved asset's remaining useful life).
Land
the site of manufacturing facility or office building used in operations. (Land purchased for future use or as an investment is not considered part of property, plant, and equipment.
Operating assets are held until
their service potential has been exhausted.
Natural resources differences
unlike fixed assets, natural resources are physically consumed as they are used by a company. natural resources can generally be replaced or restored only by an act of nature. (Timberlands are renewed by replanting and growth, but coal deposits and most mineral deposits are not subject to renewal).
Disposal of fixed assets
voluntary disposal and involuntary disposal
Units-of-production method
when the decline in asset's service potential is proportional to the usage of the asset and asset usage can be measured, depreciation expense can be computed using this method.
Intangible assets
which generally result from legal and contractual rights, do not have physical substance. They include patents, copyrights, trademarks, licenses, and goodwill.
These costs are said to be capitalized
which means that they are reported as long-term assets with a service potential of greater than 1 year.