Accounting Exam 4

Declining-Balance Method

(cost-residual value) x (2/useful life) If an asset is considered to be more productive when it is newer, managers might go with this method. Why? You are matching higher depreciation expense with higher revenues in the early years of an asset's life.

Units-of-Production Method

(cost-residual value) x (actual production this period/estimated total production) Depreciated cost is related to total estimated productive output. Depreciation Expense, Accumulated Depreciation, and Book Value vary directly with the number of units produced.

Straight-line Method

(cost-residual value)/useful life An equal portion of an asset's depreciable cost is allocated to each accounting period. Depreciation Expense is constant per period. Accumulated Depreciation goes up by an equal amount each year. Net Book Value decreases by the same amount each year until it equals the estimated residual value.

Depreciation calculations require three amounts for each asset:

1. Acquisition cost. 2. Estimated useful life. 3. Estimated residual value.

Depreciation Methods:

1. Straight-line 2. Units-of-production 3. Declining balance

Liabilities are created when a company:

1.Buys goods and services on credit 2.Obtains short-term loans 3.Issues long-term debt

Measuring and Recording Acquisition Cost: Land

A company may acquire undeveloped land with the intent to build a new factory or office building. Purchase cost, Legal fees, Surveying fees, Broker's commissions, Title fees, Title Insurance Sometimes a company purchases an old building or used machinery for business operations. All renovation and repair costs are included prior to the assets use.

Liabilities

A company will have several kinds of liabilities and a wide range of creditors. The list of liabilities on the balance sheet differs from one company to the next because different operating activities result in different liabilities. Current liabilities are short-term obligations that will be paid with current assets within the company's current operating cycle or within one year of the balance sheet date, whichever is longer.

Franchises

A franchise provides legally protected rights (a contract) to sell products or provide services purchased by a franchisee from the franchisor. Life of the franchise agreement depends on the contract

Patents and Licensing Rights

A patent is an exclusive right granted by the federal government to sell or manufacture an invention to allow the creator to earn an economic return on the new product. Cost is purchase price plus legal cost to defend Amortize cost over the shorter of useful life or 20 years Licensing and operating rights obtained through agreements with governmental units or agencies. Limited permission to use a product or service according to specific terms and conditions. Ex. Airwaves for radio and television broadcasts, land for cable and telephone lines

Trademarks and Copyrights

A trademark is a special name, image, symbol, design, slogan, or logo associated with a business. Internally developed trademarks have no recorded asset cost Purchased trademarks are recorded at cost A copyright is an exclusive right granted by the federal government to protect artistic or intellectual properties Legal life is life of creator plus 70 years Amortize cost over the period benefited

Current Liabilities: Accounts Payable

Accounts Payable is increased (credited) when a company receives goods or services on credit, and it is decreased (debited) when the company pays on its account. Accounts Payable is interest free unless it becomes overdue.An inexpensive way to finance the purchase of inventory because interest does not normally accrue on accounts payable.

Long-Lived Tangible and Intangible Assets Acquisition, Use, and Disposal ("Property, Plant, and Equipment" and "Natural Resources")

Actively Used in Operations → Will not be used up within the next year On the Balance Sheet, listed under Non Current assets section.

Long-term liabilities

All obligations that are not current liabilities and will require payment more than one year into the future. Many companies will borrow money on a long term basis in order to purchase operational (long-lived) assets, such as property and equipment.A company will do this in situations where the need for debt capital financing is greater than the ability to secure funds from any one source.Examples of long term liabilities are long term notes payable, bonds payable, and mortgage payable. Secured debt = a loan supported by a specific asset as security for repaymentUnsecured = relies on the borrower's integrity

Measuring and Recording Acquisition Cost

All reasonable and necessary expenditures made in acquiring and preparing an asset for use needs to be recorded as the cost of the asset. Recording costs as assets is called capitalizing the costs (capitalizing means "added/assigned to the cost of the asset"). We do not call these costs, expenses. These costs can include sales taxes, legal fees, transportation costs, and installation costs to get the asset ready for use.

Current Liabilities: Deferred Revenues

Cash comes in before delivery of the goods or services.

Long-term liabilities: Long-Term Notes Payable

Companies can raise capital directly from financial service organizations -banks, insurance companies, pension plans.Sometimes a company's capital requirements exceed what a bank or banks can provide. In a situation such as this, the company may issue publicly traded debt (bonds). Accounting for long-term debt is similar to what we studied in accounting for short-term notes payable. A liability is recorded when the debt is incurred and interest expense is recorded with the passage of time.

Current Liabilities: Contingent Liabilities

Contingent liabilities are potential liabilities that arise from past transactions or events, but their ultimate resolution depends (is contingent) on a future event.

Goodwill

Cost in excess of net asset acquired Occurs when one company buys another company - favorable reputation due to customer confidence, reputation for good service, or quality goods, location, outstanding management team, financial standing Is not amortized Most frequently reported intangible asset

"Capital Structure" -- A business finances the purchase of their assets by way of two external sources:

Creditors (Debt) Owners (Equity)

The Concept of Depreciation

Except for land, which has an unlimited life, long-lived asset represent the prepaid cost of a bundle of future benefits. Depreciation is the process of allocating the cost of buildings or equipment over its productive life. Said another way, the matching principle requires that a portion of an asset's cost be allocated as an expense in the same period that revenues were generated by its use. It is a process of cost allocation, not a process to determine an asset's current market value or worth. Net Book Value (= Acquisition Cost - Accumulated Depreciation) is also known as Carrying Value or Book Value. Depreciation is an estimate - estimated useful life is the management's estimate of the asset's useful economic life to the company. It can be calculated by year or units of capacity, machine hours, or number of units produced.

Intangible Assets

Have value because of certain rights and privileges bestowed by law to the owner Noncurrent assets without physical or tangible substance Useful life is often difficult to determine Usually acquired for operational use Becoming more important due to the expansion in computer information systems (web technologies, intellectual property development) Included on balance sheet only if purchased Ex. Customer lists/relationships, no compete covenants, contracts and agreements. Amortize intangibles with limited lives over the shorter of their economic lives or legal lives using the straight-line method.

Measuring Asset Impairment

Impaired = an event or circumstance that causes future cash flows (probable future benefits) of an asset to fall below the asset's book value. Examples noted below. Casualty. Obsolescence. Lack of demand for the asset's services.

Disposal of Property, Plant, and Equipment

In some cases a business may dispose an asset involuntarily due to an event -storm, fire, theft, or accident. Sometimes these events are voluntary and the company may decide not to hold a long-lived asset to the end of its entire estimated life. Ex. A piece of equipment that is no longer needed, replacing a machine with a more efficient one. 1. Update depreciation to the date of disposal. 2. Record the disposal by: a. Recording cash received (debit) or paid (credit).Writing off accumulated depreciation (debit). b.Recording a gain (credit) or loss (debit). Writing off the asset cost (credit). If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). Any gain or loss from the disposal goes on the income statement. Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years.

Repairs, Maintenance, and Additions: "Additions and Improvements"

Increase productive life, operating efficiency, or capacity. Occur infrequently, often require large amounts of money, and increase an asset's economic usefulness in the future through efficiency or longer life. These are known as Capital Expenditures. When journalized, they are added to an asset account and depreciated over future periods. This process can be very subjective and auditors review the items reported as capital expenditures and ordinary and maintenance closely.

Current Liabilities: Accrued Liabilities

Liabilities that have been incurred but not yet paid.Examples: property taxes, electricity, salaries, rent. Accrued Taxes Payable - federal taxes on income they earn Accrued compensation and related costs - earned salaries that have not yet been paid. This can also include unpaid benefits, such as retirement programs, vacation time, and health insurance.They are recorded as adjusting entries at the end of the year.

Repairs, Maintenance, and Additions: "Ordinary Repairs and Maintenance"

Maintain the productive capacity of the asset during the current accounting period. Expenses here are called Revenue Expenditures. When journalized, they are recorded as expenses.

Repairs, Maintenance, and Additions

Many assets require substantial expenditures during their useful life in order to maintain their productive capacity. These expenditures include cash outlays for ordinary repairs and maintenance, major repairs, replacements, and additions. Depending on the nature of the cost, these expenditures are recorded to either an expense or an asset account.

Current Liabilities

Many of these have a direct relationship to the operating activities of a business. That is, they help finance the business.

Natural Resources and Intangible Assets

Natural resources are assets that occur in nature. Think of them as the development of raw materials. Examples include mineral deposits (gold, iron, ore), oil wells, timber tracts. They are often called wasting assets as they are depleted (physically used up.) Depletion is the process of allocating a natural resource's cost over the period of its extraction. Depletion is similar in concept to depreciation.Depletion that is computed for a period is first added to inventory and then expensed when the inventory is sold. The journal entries would be: Inventory (debit), Asset (credit). When expensed, COGS (debit) and Inventory (credit).

Intangible:

No Physical Substance Their value is represented by rights (to the owner) that produce benefits. Ex. Patents, Copyrights, Licenses, Franchises, Trademarks

Tangible:

Physical Substance Ex. Land Buildings, Fixtures, and Equipment Natural Resources- Timber Tracts, Silver Mines

Measuring and Recording Acquisition Cost: Buildings

Purchase/construction cost Legal fees Appraisal fees Architectural fees

Measuring and Recording Acquisition Cost: Equipment

Purchase/construction cost Sales taxes Transportation costs Installation costs

Current Liabilities: Current Portion of Long Term Debt

Reclassifying the portion of long term debt due to be paid within one year.

What factors do managers consider when they borrow money?

Risk and cost. Debt capital is more risky. Payments associated with debt are a company's legal obligation. There is the potential for bankruptcy - require the company to sell off assets to satisfy what is owed.

Technology

Website and computer software development costs being the big ones

Current Liabilities: Notes Payable

When a company borrows money and a formal written contract is prepared. Companies record interest expense for a given accounting period, regardless of when they actually pay the back cash for interest.Interest will be expensed during the period in which the money is used. Calculating interest involves 3 variables - principle, annual interest rate, and time period.