Chapter 9
Four factors in calculating depreciation
-cost -salvage (residual factor) -depreciation base -estimated useful life -no matter what method is used, depreciation expense is the same over the life of the asset if it is held to the end of its useful life
Capital expenditures
-increase the book value of long-lived assets. To capitalize an amount means to increase an assets book value by that amount. The following list identifies two typical capital expenditures related to property, plant, and equipment -initial acquisitions and additions -betterments
common intangible assets
-patents- -copyrights- -trademarks -goodwill -many more types
Deferred payment purchases
If an assets purchase price is not immediately paid in cash, the cash equivalent purchase price at the date of acquisition is determined and recorded in the asset account
Units of production method
generally based on an output associated with the assets -allocates depreciation in proportion to an assets use in operations. Under this method, the depreciation per unit of production is first calculated by dividing the total depreciable cost of the assets
double declining balance method
uses a depreciation rate that is twice the straight line rate, 150 percent-declining balance depreciation uses a depreciation rate that is one and one-half times the sight line rate
Amortization expense
Attempting to match the cost of the asset with the years in which it will help to generate revenues. Not all intangible assets are amortized
Depreciation expense
Attempting to match the cost of the assets with the years in which it will help to generate revenues. Plant assets, with the exception of land are depreciated -the portion of an assets's cost that is consumed or used up in a given period, Depreciation expense when referring to plant assets, and amortization expense, and amortization expense when referring to intangible assets
book value
acquisition cost- accumulated depreciation
initial acquisitions and additions
additions to existing plant assets, adding a new wing to building or expanding the size of an asphalt parking lot are examples of additions. These capitals expenditures should also be debited to an asset account. A seperate account (and depreciation schedule) should be used for an addition when its estimated useful life differs from the remainging useful life of the exciting plant asset
straight-line equation
annual depreciation=(acquisition cost-salvage value)/estimated useful life(in months or years)
units-of production method- annual deprecation
annual depreciation=depreciation per unit x units of production for the period
leasehold improvements
another seperate balance sheet account -expenditures made by a business to alter or improve leased property ex. merchandising firm may make improvements, with the permission of the owner, to lease building. The improvements or alterations, become part of the leased property and revert to the owner of the property at the end of the lease. The cost of the leasehold improvements is capitalized to the leasehold improvements account on the balance sheet and is depreciated over the life of the lease or the life of the improvements
Betterments
are expenditures that 1) extend the useful life of an asset 2) improve the quality and/or quantity of the assets output 3) reduce the assets operating expenses ex. include overhauling the engine or adding a power winch to a highway service truck, improving the precision of a machine device to reduce defects, or converting a building to solar power expenditures for betterments are generally debited to the appropriate asset account and the subsequent periodic depreciation expense is increase to allocate the additional cost over the assets remaining useful life
plant assets ex.
ex. Building, equipment, tools,furniture, fixtures, vehicles term for the periodic write-off to expense -depreciation
depreciation
ex. a plant asset is acquired for 1000, used for several accounting periods, and then sold for 100. The 900 decline in recorded value is the depreciation and is an expense of generating the revenues recognized during the periods that the asset was in use.
intangible assets ex.
ex.Patents, copyrights, leaseholds, franchises, trademarks, brand names Term for the periodic write-off to expense -amortization
Revenues expenditures
expended in the period incurred. Generally revenue expenditures are for: -ordinary maintenance and repairs on existing plant assets -Items that are too immaterial to "capitalize". Each company establishes its own threshold of materiality
declining balance method
is an accelerated depreciation method. It calculates a company's depreciation expense as a constant percentage of an assets book value as of the beginning of each period. The method is considered to be an "accelerated" method because the constant depreciation percentage it uses a multiple of the stright line depreciation rate
The carrying value of long-lived assets
is initially based on the assets historical cost that is, the cost incurred to acquire and place the assets into a revenue-producing state. The cost related to the use of long-lived assets must be matched with the revenues that they help to generate to insure that a business's net income is correctly determined
depreciation accounting
is simply an attempt to allocate, in a systematic and rational manner, the difference between an assets acquisition cost and estimated salvage value over the estimated useful life of the asset. depreciation accounting techniques are just convenient expenditures for estimating asset utilization and should not be considered precise.
straight-line method
is the easiest depreciation method to understand and calculate. Consequently, this method is the most widely used depreciation method by U.S. businesses. Under the straight line method, an equal amount of depreciation expense is allocated to each period of an asset's useful life.
Useful life
is the expected period of economic usefulness to a business- that is the period from the date of acquisition to the expected date of disposal.
historical cost/acquisition cost of long-lived assets
it represents the amount expended when the asset was originally acquired. in general the assets equals the cash and or/ cash equivalent given up to acquire the asset and to prepare it for its intended use
Low-cost items
most businesses purchase items that provide years of service at a relatively small cost, such a paperweights, staplers, and waste baskets. Because of the small dollar amounts involved, estimated these items as assets on the balance sheet and depreciating them over their expected useful lives serves no useful purpose
Franchise
most often involve exclusive rights to operate or sell a specific brand of products in given geographic area
intangible assets
normally follow property plant & equipment on the balance sheet. Not responsible for return on assets and asset turnover
-copyrights
protects its owner against the unauthorized reproduction of a specific written work, recorded work, or artwork. A copyright lasts for the life of the author plus 70 years
Modified Accelerated Cost Recovery System (MACRS)
A depreciation method that is used for tax purposes. -The depreciation expense deducted on a business's income tax return, however may differ substantially from the depreciation expense reported on a company's income statement because the calculation of tax depreciation follows income tax regulations referred to as MACRS -MACRS was introduced to encourage companies to invest in plant assets -establishes 8 assets classes with prescribed useful lives ranging from 3 to 31.5 years
The cost of the lump-sum (package)
purchases are allocated to the assets based on the related fair values of the assets
asset turnover
asset turnover = net sales/average total assets
Note:
assets are not depreciated below their estimated salvage value
the total estimated units of production
may represent the total expected miles that an asset will be driven, the total tons expected to hauled, the total hours expected to be used, or the total number of expected cuttings, drillings, or stampings of parts by a piece of equipment ex. assume that a drilling tool will drill an estimated 45,000 parts during its expected useful life. The tool is purchased for 1000 and has an expected salvage value of 100 (1000-100)/45,000=.02 per part
trademarks
represent the exclusive and continuing right to use certain terms, names, or symbols usually to identify a brand or family of products. an original trademark or trade name can be registered with the US federal government for a nominal cost
journal entry for impairment loss
(debit)impaired loss on equipment (credit)accumulated depreciation- equipment
Salvage (residual)value
(or residual value) is the expected net recovery (sales proceeds less disposal costs) when the asset is sold or removed from the service. When salvage value is insignificant, it may be ignored in the depreciation process under the materiality concept
Long lived assets
(plant assets, capital assets, fixed assets are synonyms) are recored at historical cost-The cost of the asset and the cost of getting it ready for its intended use (the cost principle) -are recorded on the balance sheet at their acquisition cost
assets sales for more than book value
-Assume that the equipment is sold $230 midway through its fifth year of use. Depreciation was last recorded at the end of the fourth year. (debit)depreciation expense-equipment (credit) accumulated depreciation-equipment -to record depreciation expense for 6 months (debit)cash (debit)accumulated depreciation-equipment (credit) equipment (credit) gain on the sale of plant assets -to record the sale of equipment for 230
asset sales for less than book value
-assume that the equipment is sold for 30$ at the end of the fifth year (debit)cash (debit) loss on sale of plant assets (debit) accumulated depreciation-equipment (credit) equipment to record the sale of equipment of $30 -The loss on the asset sale equals the book value of 100 minus the sales proceeds of 30. The cash received is recorded, and the balances from both the equipment account and the accumulated depreciation account are removed from the books
Cash purchases- assets acquisition cost
-is often simply the amount of cash paid when the asset is acquired and readied for use by a business. -cash purchase price and related preparation costs, the sales tax is a necessary component of the purchase price and should also be included in the assets acquisition cost. Similarly, the cost of fright, installation, and testing are expenditures necessary to get the asset to the desired business location and ready for its intended use.
Analyzing long-term assets
-return on assets -assets turnover
Accounting for long lived assets(cost determination)
1) Identifying the type, and amount, of expenditures that make up the acquisition cost of the asset. 2) Determine the appropriate amount of an assets cost to periodically charge against revenue to reflect the assets consumption. This involves estimating the assets useful life and its probable salvage value at disposal. 3) Differentiating those expenditures related to maintenance of an asset from those expenditures that increase an assets productive capacity or extend its useful life. 4) Determining any gain or loss to recognized when a long loved asset is disposed of.
3 methods of calculating depreciation expense
1) straight-line(salvage value matters at start) 2) Declining balance (salvage value matters at end) -Units of production (salvage value matter at start)
Sale of plant assets
1) the sale transaction involves an exchange of a used plant asset for a cash. Because the plant asset sold is no longer on hand, a journal entry must remove the asset account and the accumulated depreciation account from the books. These amounts together reflect the assets book value 2) because plant assets are often sold for an amount higher or lower than their book value, a gain or loss will result. Sale proceeds in excess of book value create a gain, whereas book values in excess of sales proceeds create a loss
Deferred payment purchases example
Smith and son purchased its equipment under a financing plan requiring a $400 cash down payment and nine percent, $10000 note payable due in one year. The implied cash price remains 10400 even though more than 10400 is eventually paid under the financing plan (400 down payment +10000 principle payment on note+ $900 interest payment=11300) -becuase the equipment is ready for imitate use, the extra $900 paid as interest is charged to interest expense and does not become part of its acquisition cost. Purchase equipment under financing plan Debit(equipment 10,400) credit(cash 400) (notes payable 10,000) -as in the case of cash purchase, the expenditures for fright, installation, and testing are debited to the equipment account when incurred
declining balance method- named
The method takes its name from the fact that, over time, an assets book value (acquisition cost- accumulated depreciation) declines as the asset is used up, yielding a decreasing depreciation expense. An assets salvage value is not considered in the calculation of declining-balance depreciation, except that the depreciation of an asset stops when the assets book value equals its estimated salvage value.
plant assets- Long term assets
The property, plant and equipment (property plant&equipment) of the company -measuring acquisition cost of plant assets -recording plant assets -computing depreciation -revenue and capital expenditures -disposing of plant assets
expenditures related to land
The purchase of land often raises a number of accounting issues -any expenditure for the property taxes, insurance, and legal fees should be capitalized or added to, the acquisition cost of the land because they are necessary to complete the purchase transaction. Similarly, removing the old building also prepares the land for its intended use. The 200 net recovery from razing the existing structure, therefore, reduces the lands cost. A net payment to remove the old building would have increased the land's cost.
depreciation method estimate changes
a business's periodic depreciation expense is based on estimates on both an assets useful life and its salvage value. Circumstances change, however, and original estimates of both an asset's useful life and its salvage value may subsequently be found to be too high or too low. Once it is determined that the original estimates of either an assets useful liftoff slave value was incorrect, the calculation of the periodic depreciation expense for an assets reaming useful life may be revised
impairment loss
a depreciable asset is so severe that the future cash flows from the assets use and disposal are estimated to be less than its current book value. If an assets remain books value cannot be recovered through the future cash flows expected to be generated from the assets use, the assets value is to be impaired. recorded in income statement and the assets book value on the balance sheet is reduced. -is calculated as the difference between the assets current book value and its current fair value
when a land site is acquired in an underdeveloped area
a firm may pay a special assessment to the local government to the local government for such property improvements as streets, sidewalks ,and sewers. These improvements are considered to be permanent improvements, and consequently, the special assessment is added to the acquisition cost of the land
patents
a patent is an exclusive privilege granted to an inventor by the US patent office for a period of 20 years from the date the patent application is filed. A patent gives the holder the right to excuse others from making, using or selling the invention
Exchange of plants assets
a plant asset may be exchanged for another plant asset. The accounting for the long-lived asset exchanges can be complex depending upon the relationship between the new asset and the asset being traded in.
land improvements
a separate balance sheet account. Land improvements are depreciated -limited lives, they include such improvements as parking lots, driveways, private sidewalks, and fences. Expenditures for these assets are charged to a separate land improvements account on the balance sheet and depreciated over the estimated useful life of the improvements
Intangible assets
are the various resources that benefit a business's operations but which lack physical characteristics or substance. Intangible assets include the exclusive rights or privileges obtained from a governmental unit or by legal contract, such as patents, copyrights, franchise, trademarks, and leasehold. and goodwill which reflects the beneficial attributes acquired in the acquisition of another company that cannot be attributes to any other recored asset -most intangible assets are amortized(generally on a straight line basis) Unlike depreciation, generally an accumulated amortization account is not uses, rather the asset is credited
thus a company's net income is to be a meaningful representation of the business's operating performance, 900 of expense must be allocated to the period of the asset use and matched with sales revenue. Failure to do so would over state the company's net income for those periods
as part of the allocation process, it is first necessary to estimate the assets useful life and its expected future salvage value
double declining balance method- annual depreciation expense
book value at begging of the year x double declining balance rate
Depreciation and amortization
both refer to the process of allocating a portion of an assets acquisition cost to expense on the income statement to reflect the consumption of the asset as it produces revenue for a business
the depreciation schedule
depreciation expense is deducted from sales revenue on the income statement and is closed at year end to the income summary account. The offsetting credit entry is posted to the contra-asset account, accumulated depreciation, which is deducted from the equipment account on the balance sheet to calculate the assets book value. In this manner
straight-line journal entry
depreciation expense-equipment accumulated depreciation-equipment
Disposals of plant assets
depreciation must extend through an assets total useful life to a business. Consequently, depreciation must be recorded up tp the disposal date regardless of the manner of the assets disposal. Should the disposal date not coincide with the end of the accounting period, a journal entry must record depreciation for the partial period-that is, the period from the date that depreciation was last recorded to the assets disposal date. data for disposal of plant asset -equipments acquisition cost -estimated salvage value after five years -annual straight-line depreciation
Units of production method equation
depreciation per unit=(acquisition cost-salvage value)/total estimated units of production
Intangibile assests
refer to those economic resources that benefit a company's operations but which lack the physical substance that characterizes plant assets ex. copyright, franchise, and patents -Measuring intangible assets costs -recording intangible assets -computing amortization -examples of intangable assets -balance sheet presentation of intangible assets (long term assets of significant value but do not have a physical substance and are not financial instruments
goodwill
represents the amount paid by one company in the acquisition of another company, above the amount that can be attributed to the identifiable net assets of the acquired company, including the other intangibles like those discussed above
return on asset equation
return on assets=net income/avergage total assets
Record the cash received, take the equipment and the related accumulated depreciation off the books and the entry to balance should equal your gain(loss)
sale of plant assets-sell price-book value of asset= gain(loss)
maintenance and repairs
some level of maintenance and repairs must be assumed when estimating the useful lives and salvage values of property, plant and equipment. ex. a plant asset that is not maintained will have a shorter life than an asset taken care of
Package purchase
sometimes several long-lived assets are purchases as a package -smith purchased a freight terminal that included land, a building and some loading equipment for an aggregate price of 190,000. for account purposes the total purchase should be divided among three assets because 1) they should reflect ported in different asset accounts on the balance sheet to properly reflect the company's asset structure 2)only the building and equipment are subject to depreciation 3)the equipment is likely to have an estimated useful life different from that of the building.