MGMT 200 Chapter 7

Companies acquire intangible assets in two ways

*Purchased *Developed internally •Existence often based on legal contract

Declining-balance

*This method is an accelerated method, meaning that more depreciation expense is taken in the earlier years than in the later years of an asset's life. *Declining-balance methods are also used in calculating depreciation for tax purposes. *However, both declining-balance and straight-line will result in the same total depreciation over the asset's service life.

Recording Depreciation

*increase depreciation expense and *increase accumulated depreciation. . Rather than credit the Equipment account directly, we instead credit its contra account, which we offset against the Equipment account in the balance sheet

Depreciation Expense

=asset's cost - residual value / service life

Depreciation

Accounting definition = Allocation of an asset's cost to an expense over time.

Land Improvements

Land improvements have limited useful lives and are recorded separately from the Land account

Amortization Treatment of Intangible Assets

Management must review long-term assets for a potential write-down when events or changes in circumstances indicate the asset's "recoverable amount" is less than its "recorded amount" in the accounting records.

Why do so many companies use the straight-line method?

Many probably believe they realize benefits from their plant assets approximately evenly over these assets' service lives. Certainly another motivating factor is that straight-line is the easiest method to apply.

Three Methods of Asset Disposal

Sale: the most common method to dispose of an asset. Retirement: Occurs when a long-term asset is no longer useful but cannot be sold Exchange: Occurs when two companies trade long-term assets

Two-Step Impairment Process

Step 1: Test for impairment: The long-term asset is impaired if future cash flows are less than book value. Step 2: If impaired, record impairment loss: The impairment loss is the amount by which book value exceeds fair value

Comparison of Depreciation Methods

Straight-line creates an equal amount of depreciation each year. Double-declining-balance creates more depreciation in earlier years and less depreciation in later years. Activity-based depreciation varies depending on the miles driven each year.

Straight-line

This method allocates an equal amount of depreciation to each year. The implication is that the asset is used evenly over its useful life. This method is by far the simplest and most common depreciation method used in financial accounting.

Activity-based

This method calculates depreciation based on the activity associated with the asset. For example, a vehicle can be depreciated based on the miles driven, or a machine can be depreciated based on the hours used. The method is commonly used to allocate the cost of natural resources.

Property, Plant, and Equipment

We record a long-term asset at its cost plus all expenditures necessary to get the asset ready for use.

Profit margin

indicates the earnings per dollar of sales = Net income/net sales

Amortization of Intangible Assets

is allocating the cost of intangible assets to expense •Most intangible assets have a finite useful life that can be estimated. •Most companies use straight-line amortization for intangibles.

Tax Depreciation

•Accelerated methods reduce taxable income more in the earlier years of an asset's life •Most companies use: --> Straight-line for financial reporting --> Accelerated for tax reporting - called MACRS

Copyrights

•Exclusive right of protection given to the creator of a published work •Granted for the life of the creator plus 70 years •Allows holder to pursue legal action against anyone who attempts to infringe the copyright •Accounting is virtually identical to that of patents

Tangible assets

land, land improvements, buildings, equipment, and natural resources

Asset Turnover

measures the sales per dollar of assets invested = Net sales/ average total assets

Intangible assets

patents, trademarks, copyrights, franchises, and goodwill.

Materiality

•An item is said to be material if it is large enough to influence a decision. •When an expenditure is not material, the item is typically recorded as an expense regardless of its expected period of benefit. •Companies generally have policies regarding amounts that are not material. They will expense all costs under a certain dollar amount, say $1,000, regardless of whether future benefits are increased.

Patents

•Exclusive right to manufacture a product or to use a process *Granted for a period of 20 years * When purchased, capitalize the purchase price plus legal and filing fees *When developed internally, capitalize legal and filing fees only

Goodwill

•Goodwill is the portion of the purchase price that exceeds the fair value of identifiable net assets •Recorded only when one company acquires another company •Net assets = assets acquired less liabilities assumed

Return on Assets

•Indicates the amount of net income generated for each dollar invested in assets =Net income/ Average total assets

Land

•Land includes the cost of the land and all expenditures necessary to get the land ready for its intended use •Costs to get the land ready for use include items such as: *Real estate commissions and fees *Back property taxes or other obligations *Clearing, filling, and leveling the land *Cash received from selling salvaged building materials reduces the cost of land

Franchises

•Local outlets that pay for the exclusive right to use the franchisor's name and to sell its products within a specified geographical area •The franchisee records the initial fee as an intangible asset •Additional periodic payments to the franchisor are usually expensed as incurred

Basket Purchases

•Purchase of more than one asset at the same time for one purchase price •Because we need to record land, building, and equipment in separate accounts we must allocate the total purchase price based on the relative fair values of the individual assets

Factors Used in Calculating Depreciation

•Service life (or useful life)—The estimated use the company expects to receive from the asset before disposing of it. •Residual value (or salvage value)—The amount the company expects to receive from selling the asset at the end of its service life. •Depreciation method—The pattern in which the asset's depreciable cost (original cost minus residual value) is allocated over time.

Depreciation Methods

•Three common methods: *Straight-line *Declining-balance *Activity-based

Expenditures After Acquisition

•We capitalize an expenditure as an asset if it increases future benefits. •We expense an expenditure if it benefits only the current period. ex) repairs & maintenance, additions, improvements, legal defense of assets

Trademarks

•Word, slogan, or symbol that distinctively identifies a company, product, or service •Renewable for an indefinite number of 10-year periods •Capitalize legal, registration, and design fees

Intangible assets developed internally:

•expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs. *Difficult to determine portion of the expense that benefits future periods.

Equipment

•machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures . The cost of equipment is the actual purchase price plus all other costs necessary to prepare the asset for use. •Recurring costs such as annual property insurance and annual property taxes on vehicles are expensed as incurred

Natural Resources

•oil, natural gas, timber, and salt •Distinguished from other assets by the fact that they are physically used up, or depleted •Recorded at cost plus all other costs necessary to get the natural resource ready for its intended use

Purchased intangibles

•record at their original cost plus all other costs necessary to get the asset ready for use. *Similar to reporting purchased property, plant, and equipment.