Chapter 7 financial
Estimated residual value
(aka SCRAP or SALVAGE value) the expected cash value of an asset at the end of its useful life. What you get after selling the asset, or its value when it is obsolete
Two categories of intangibles
1) Intangibles with FINITE lives that CAN be measured 2) Intangibles with indefinite lives, record no amortization for these intangibles. Accounting for each type of tangible is unique
Depreciation expense cause
1) Physical wear and tear: physical deterioration takes toll on usefulness of physical plant assets 2) Obsolescence: Computers and technology/electronic equipment become obsolete when another asset/technology can do the job more efficiently. An assets useful life usually shorter than its physical life.
Depreciation expense is not
1) a process of valuation: biz don't record depreciation based on changes in the market 2) Not a cash fund: setting aside cash to replace an asset as they wear out
How to measure depreciation
1) cost 2) estimated useful life 3) estimated residual value
Modified Accelerated Cost Recovery System Yearly Identification
1-14 years asset = DDB 15-20 = 150% DDB 21+ = SL
Accumulated depreciation
Balance sheet
Immediate expense
Costs that don't extend the assets capacity or useful life and just maintain it or restore to working order are IMMEDIATELY EXPENSED EX: Cost of repairing a truck, fender, repainting a truck, Ordinary repairs: repair of transmission, oil change, lubrication, replacement of tires, windshield, paint job ETC.
Depreciated cost
If theres no expected residual value, the full cost of an asset is depreciated Depreciable cost = assets cost - estimated residual value
Natural resources
Long term assets, often called "wasting assets" because they are physically used up over time. Their depreciation is called "depletion."
Part of month where depreciation occurs / does not occur
Most businesses record NO monthly depreciation on assets purchased AFTER the 15th of the month.
Real estate under MACRS
Most real estate is depreciated by the straight line method
Objective of GAAP vs objective of IRC
Objective of GAAP is to provide useful information for making economic decisions. Objective of IRC is to raise sufficient revenue to pay for federal gov expenditures
Land improvements
These assets are located on land, but not part of the land. They are subject to decay and are deppreciated
Depreciation methods
Three main depreciation methods 1) Straight Line 2) Units of production 3) double declining balance
difference between GAAP and IFRS in reported carrying values of property, plant, equipment.
US GAAP = Historical cost principle IFRS = Periodic revaluation of plant assets to fair market value.
Difference between GAAP and IFRS in depreciation technique
US GAAP = depreciates each asset as a composite whole. The entire building, the entire aircraft. IFRS = Uses a "COMPONENTS APPROACH." A building depreciated under IFRS treats the building eperate components and assets such as; the fixtures, plumbing, lighting, air conditioning, duct work etc. This is because each component may have a significantly lower life expectation/value.
Units of production method
a fixed amount of depreciation is assigned to EACH unit of output, or service, produced by the asset. This fixed amount is then multiplied by number of units produced each period to calculate depreciation expense Units of production depreciation per unit of output = cost - residual value/ useful life, in units of production
Change in accounting estimate
after an asset in use, the changing of the useful life of an asset based on experience and new information assets remaining depreciable book value / new estimated useful life remaining = new annual depreciation
Intangibles with finite lives
amortization is recorded for these intangibles, usually computed on a straight line basis, credited directly to asset account
Double declining-balance method
an accelerated depreciation method which writes off a larger amount of the assets cost near the start of its life than the straight line. 1) compute straight line depreciation per year. (1/x) (x=years that the asset is in use) An asset with 5 year life has SL depreciation rate of 1/5 or .20 (20%) each year 2) multiply the straight-line rate by 2 to compute the DDB rate. 1/5 x 2 = .40. (1/5 = sl rate, 1/5 x 2 = DDB rate) 3) multiply DDB rate by periods beginning asset book value. THIS IS NOT SUBTRACTED BY RESIDUAL VALUE. 4) the final years depreciation amount is the amount needed to reduce assets book value to its residual value. (if an asset has 5 years of life and at its fourth year the book value is 5000, and the asset has a residual value of 1000, than the last years depreciation amount would be 4000.)
Straight Line Method
an equal amount of depreciation is assigned for each year/period that asset is used. straight line method = cost - residual value / useful life in years
Cost of constructing a building
architectural fees, building permits, contractors charges, payments for material, labor, and overhead. Cost of interest on money borrowed to finance construction
Fully depreciated asset
asset that has reached the end of its estimated useful life. Fully depreciated asset is not unless and may be used for years after, not further depreciated.
Lump-sum purchases of assets
buying assets as a group or a "basket"
Intangibles with indefinite lives
check these annually for any loss in value (impairment) and record a loss when it occurs. Goodwill is the most prominent example of an intangible asset with indefinite life.
Depletion
depletion tracks the flow of a natural resource from its raw state, to inventory, to COGS.
Capital expenditure
expenditure that increases the assets capacity or extends its useful life. Capital expenditures are CAPITALIZED = cost is added to an asset account NOT immediately expensed. EX: The cost of a major overhaul that extends the useful life of a FedEx truck is a capital expenditure. Extraordinary repairs: major engine overhaul, modification of body for new use of truck, addition to storage capacity of truck
Patents
federal government grants that give holder exclusive rights for 20 YEARS to produce and sell an invention (product or process.) Suppose an 170,000 patent lasts 5 years, the yearly depreciation is 170000/5 = 34000 patent - debited cash - credited - to aquire a patent amortization expense patents (170000/5) - debit patents - credit - to amortize cost of patent - patents account is credited directly (no accumulated amortization acount)
Depreciation for partial years
full year depreciation x fraction of the year that asset was held (x/12) = depreciation for partial years
Advantages of accelerated depreciation
helps conserve cash for the business because it reports the highest expense payment first, allowing for company to reinvest the tax savings back into the business earlier. More expenses first = less income less income = less income to be taxed less income to be taxed = lower tax payments for the beginning of the company which allows for excess revenue/ cash available
Loss on disposal of depreciated asset
if asset is disposed of before no longer being depreciated, the company occurs a loss on the disposal in the amount of the assets net-book value Loss on disposal of equipment / asset is reported on the OTHER INCOME (expense) on the INCOME STATEMENT
Depreciation cost
is matched against the revenue the asset helps to earn each period
Intangible assets
long lived assets with no physical form. they carry special rights like patents, copyrights, trademarks, franchises, leaseholds and goodwill. residual value of most intangibles is zero
Relative sales value method
market sales value / total market value = percentage of total market value percentage of total market value x total cost paid (not market value but what you paid) = cost of each asset
Example of non monetary exchange (gain)
papa johns has a delivery car that cost 9000, accumulated depreciation of 8000, thus old car =1000 book value/fair market value papa johns trades old car for a new car with fairmarket value of 15,000. Adds 10000 cash, so papajohns has 1000 dollar car +10000 cash = 11000. they gain 4000 by trading their 10000 and old car for the 15000 dollar car (11000-15000=4000) _____________________ delivery auto (new) - debit accumulated depreciation(old) -debit delivery auto (old) - credit cash (credit) gain on exchange of delivery auto - credit
Book value
plant assets reported on BALANCE SHEET at BOOK VALUE Book value = cost - accumulated depreciation
Cost of land
purchase price, brokerage commission, survey fees, back property taxes, expenditures for grading and clearing the land and removing unwanted buildings
equipment
purchase price, transportation from seller to buyer, sales and other taxes, purchase commission, installation costs, expenditures of texting asset prior to service.
Disposal of a fully depreciated asset
remove the asset and its related accumulated depreciation from the books Debit accumulated depreciation (contra asset) credit plant asset
Depreciation expense
reported on the income statement. Only land has an unlimited life and is not depreciated.
Modified Accelerated Cost Recovery System
special depreciation method used for income tax purposes. Each fixed asset is classified into one of eight classes identified by asset life. 15 year assets and 20 year assets are computed by the 150% declining balance method. Instead of multiplying the SL method in DDB by 2, it is multiplied by 1.50 (hence the 150%)
Land improvements
the cost of fencing, paving, security systems, and lightning, these are separate plant assets not included with land.
Estimated useful life
the length of service expected from using an asset
Cost of purchased existing building
the purchase price, brokerage commission, sales and other taxed paid, all expenditures to repair/renovate the building
Expense a cost that should have been capitalized
this error overstates expenses and understates net income
Non monetary exchange
trading an old asset for a new one, based upon the fair values of the assets involved. Any difference between the fair value of old asset from its book value is recognized as a gain (fairvalue of asset exceeds book value) or loss (fair value of old asset exceeds book value)
Capitalize a cost that should have been expensed
understates expenses and overstates net income in the year of the error
Leasehold improvements
when a company leases anything (vehicle, shop etc) and improves it. These improvements are subject to depreciation called amortization.
