principles of accounting chapter 7
loss
"other expenses and losses" debited
gain
"other revenues or gains" credited
double declining balance rate=
(2) x straight-line rate
depreciation cost per unit=
(cost-residual value)/expected usage of the asset
to find a partial year depreciation rate
(cost-residual value)/expected useful life= X (months/12) -after the good is fully depreciated a partial depreciation needs to be recorded to fully depreciate the asset
straight-line depreciation=
(cost-residual)/expected useful life
in order to measure depreciation you need
-cost of the fixed asset -useful life or expected life of the fixed asset r-esidual value or salvage value of the fixed asset
Tax depreciation rules
-designed to stimulate investment in operating assets and therefore are not guided by the matching principle -provide for the rapid expensing of depreciable assets, which lower taxes by bringing forward the bulk of depreciation expense -enable companies to save cash by delaying payment of taxes
depreciation for partial years
-if the fixed asset is purchased at the beginning or end of an accounting period, a full year of depreciation is recorded -if the asset is purchased during the accounting period the matching principle requires that depreciation be recorded only for the portion the year that the asset was used to generate revenue
most businesses choose the straight-line method because of
-simplicity and ease -method produces a higher reported income in the early years of an asset's life -once you choose a method you must stick with it
to revise a depreciation expense the following steps are performed:
1.obtain the book value of the asset at the date of the revision of depreciation 2. compute depreciation expense using the revised amounts for book value, useful life and/ or residual value
straight line rate=
1/useful life
an impairment is
a permanent decline in the future benefit or service potential of an asset -may be due to including too little depreciation expense being recorded in previous years or obsolescence of the asset
straight-line depreciation method
allocates an equal amount of an asset's cost to depreciation expense for each year of an asset's useful life -use for those asset which an equal amount of service potential be used each period
fair value
an asset is the estimated amount of cash that would be required to acquire the asset - this cash equivalent cost can be inferred from information about similar assets in comparable transactions
it is important to know that land has
an unlimited life and service potential and is not subject to depreciation
the cost of a fixed asset is
any expenditure necessary to acquire the asset and to prepare the asset for use
the expense recognition principle
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
equipment
assets used in operations machinery, furniture, automobiles
the straight-line depreciation method produces
a constant amount of depreciation expense in each period of the asset's life and is consistent with a constant rate of decline in service potential
natural resources
coal deposits, oil reserves, and mineral deposits, make up an important part of the operating assets for many companies -are physically consumed as they are used by a company. -can generally be replaced or restored only by an act of nature
expenditures after acquisition
companies must decide if repairs and maintenances are either capitalized or expensed
Modified Accelerated Cost Recovery System (MACRS)
companies use this to compute depreciation expense for their tax returns is similar to the declining balance method but is not acceptable for financial reporting purposes
depreciation is a
cost allocation process, it is not an attempt to measure the fair value of the assets value
depreciable cost
cost of the asset-residual value is the amount that will be depreciated (expensed) over the asset's useful life
depletion rate=
cost-residual value/recoverable units
organizational costs
costs such as legal fees, stock issue costs, accounting fees, and promotional -always an expense
a revision of depreciation expense is accounted for in
current and future periods
average age of fixed assets
indicates a company's capital replacement policy and assists managers in estimating future capital expenditures accumulated depreciation/depreciation expense
amortization
intangible assets
indefinite life intangibles
is not amortized but is reviewed annually for impairment
useful life
is the period of time over which the company anticipates deriving benefit from the use of the asset
companies often purchase fixed assets by
issuing debt
accounting for intangible assets
recorded at cost, consistent with the historical cost principle -similar to fixed assets, the cost of an intangible asset is any expenditure necessary to acquire the asset and to prepare the asset for use -intangible assets purchased from outside the company, the primary element of the cost is the purchase price -costs such as registration, filing, and legal fees are considered necessary costs and are capitalized as part of the intangible asset
operating assets are the
most costly of the various types of assets acquired by an entity
the declining balance method differs from the straight line method because it
multiplies depreciation rate by the book value rather than by the depreciable cost of the asset
amortization (finite life)
the cost of an intangible asset with a finite life and allocating to accounting periods over the life of the asset to reflect the decline in service potential
internally developed intangible assets
the cost of developing the asset is expense as incurred and normally recorded as research and development expense
accumulated depreciation is deducted from
the cost of the asset to get the asset's book value or carrying value -shows the disclosures relating to property, plant, and equipment and depreciation
depletion
natural resources
natural resources
naturally occurring materials that have economic value, can be timberlands and deposits such as coal, oil and gravel
fixed asset turnover ratio=
net sales/average net fixed assets -measures how efficiently a company is using its fixed assets
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
cost
of a fixed asset is any expenditure necessary to acquire the asset and to prepare the asset for use
the book value of an asset that is reported on a company's balance sheet is
often quite different from the market value of the asset
the asset is valued at the fair value of the liability
on the date the asset is acquired -thus interest on borrowed funds normally is not added to the purchase price of an asset
when non cash consideration, such as land or other non cash assets, is given up
or the fair value of the asset received whichever is more clearly determinable
deprecation
property, plant and equipment
fixed assets
property, plant and equipment or land, building, machines and automobiles
the expense recognition principle
provides the conceptual basis for measuring and recognizing depreciation and requires that the cost of a fixed asset be allocated as an expense among the accounting periods in which the asset is used and revenues are generated by its use
the cost of a machine would be its
purchase price, plus sales taxes, freight, installation costs, and the cost of labor materials for trial runs that check its performance
the historical cost principle requires that a company
record its fixed assets at the exchange price at the time the asset is purchased -when cash is paid in exchange for an asset, the amount of cash given plus any other expenditure necessary to prepare the asset for use becomes part of the historical cost
The Internal Revenue Code
this specifies which depreciation method a company should use to prepare tax returns
depreciable cost=
useful life
historical cost principle
when an operating asset is recorded at its cost, including the cost of acquiring the asset and the cost of preparing the asset for use
impairments
when the fair value of the asset falls significantly below the book value of the asset then the asset is impaired
capitalized expenditures
added to an asset account
R&D expense (research and development)
expenditures of R&D may lead to intangible assets but R&D itself is not an intangible asset -always an expense
revenue expenditures
expenditures that do not increase the future economic benefits of the asset -maintain the level of benefits provided by the asset, relate only to the current period, occur frequently and typically involve relatively small dollar amounts
cost of goods sold
expense related to natural resources
recurring costs that benefit a period of time, not the asset's life are
expensed instead of capitalized
capital expenditures
extend the life of the asset, expand the productive capacity, increase efficiency, or improve the quality of the product -provide benefits to the company in both current and future periods -capital expenditures are added to an asset account and are subject to depreciation -typically involve relatively large dollar amounts
impairment consistent with the principle of conservatism
if a fixed asset is impaired a company should reduce the asset's book value to its fair value in the year the impairment occurs
the disposal of PPE require 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(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
depreciation is not an attempt to
accumulate cash for the replacement of an asset, it is a cost allocation process
declining balance depreciation method
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 -result in a smaller depreciation expense later in an items life
revision of depreciation
based on estimates of useful life and residual value -as new or additional information becomes available a company will often find it necessary to revise its estimates of useful life, residual value or both
the useful life of any fixed asset reflects
both the physical capacities of the asset and the company's plans for its use
expenditures that new included as part of the cost of asset are
capitalized
the amount of depreciation expense is recorded each period by making the following adjusting journal entry
debit: depreciation expense credit: accumulated depreciation
the units-of-production depreciation method
decline in an asset's service potential is proportional to the usage of the asset and the asset usage can be measured
declining balance depreciation expense=
declining balance rate x book value
depletion=
depletion ratexunits recovery
cost-residual value=
depreciable cost
units-of-production expense=
depreciation cost per unit x actual usage of the asset
the allocation for the expense recognition principle is called
depreciation for property, plant, and equipment assets and amortization for intangible assets and depletion for natural resources
for many companies the largest periodic expense if
depreciation, amortization and depletion
depreciation expense depends on
estimates of both useful life and residual value, depreciation expense itself is an estimate
operating assets represent
future economic benefits, or service potential that will be used in the normal course of operations
economic benefits associated with intangible assets are
legal rights and privileges conferred on the owner of the asset
land improvements, buildings and equipment have
limited lives and limited service potential and thus these assets are recorded in separate accounts and depreciated over the periods in which they are used to generate revenue
operating assets
long-lived assets that are used by the company in the normal course of operations, they are not sold to customers but are used by a company in the normal course of operation
the units-of-production method is based on a
measure of the asset's use in each period -based on a pattern tailored to the individual asset and its use
capitalized
reported as long-term assets with a service potential of greater than 1 year
expensed expenditures
reported in total on the income statement
depreciation expense
reported on the income statement
intangible operating assets
represent future economic benefit to the company -patents, copyrights, trademarks, leaseholds,organization costs, franchises, and goodwill
accumulated depreciation
represents the total amount of depreciation expense that has been recorded for an asset since the asset was acquired -is reported on the balance sheet as a contra asset
intangible assets
result form legal and contractual rights, do not have physical substance, include patents copyrights, trademarks, licenses and goodwill
how does management choose a depreciation method?
should select the method that best matches the pattern of decline in service potential of the asset
land
site of a manufacturing facility or office building used in operations
land improvements
structural additions or improvements to land driveways parking lots, fences, landscaping, lighting
buildings
structures used in operations factory, office, warehouse
residual value (salvage value)
the amount of cash trade-in consideration that the company expects to receive when an asset is retired from service
the declining balance depreciation method accelerates
the assignment of an asset's cost to depreciation expense by allocating a larger amount of cost to the early years of an asset's life -is consistent with a decreasing decline in service potential and a decreasing amount of depreciation expense
as natural resource is extracted
the natural resource is reduced and the amount of depletion computed is added to inventory, as inventory is sold the company will recognize an expense (cost of goods sold)
depletion
the process of allocating the cost of the natural resource to each period in which the resource is used
depreciation
the process of allocating, in a systematic and rational manner, the cost of a tangible fixed asset to expense over the asset's useful like
depreciation methods
the service potential of a fixed asset is assumed to decline with each period of use but the pattern of decline is not the same for all assets -some assets decline at a constant rate, some decline sharply, and some depend on how much the asset is used each period