A201 CH 8

Tangible or intangible resources owned by a business and used in its operations over many years

Assets that have physical substance 1. Land 2. Fixed Assets: Buildings, Fixtures, & Equipment (Property, Plant, & Equipment) 3. Natural Resources

Long-Lived assets that confer special rights to their owner, but do not have physical substance ex: goodwill, patents, copyrights, franchises, licenses, and trademarks Recorded at Historical Cost only if they've been purchased.

The cost of the asset (+) sales taxes, legal fees, transportation costs, & installation costs to purchase price of asset (-) special discounts are subtracted any interest charges associated with the purchase are expensed as incurred

They are recorded as part of the cost of an asset instead of as expenses in the current period

Net Sales (or Operating Revenues)/ Average Net Fixed Assets How effectively is the company using fixed assets to generate sales? Measures sales dollars generated by each $ of fixed assets used. High rate suggests effective management Low/Declining rate may indicate company is expanding (by acquiring more assets) in anticipation of higher future sales

The total cost is allocated to each asset in proportion to the asset's market value relative to the total market value of the assets as a whole

Title fees, sales commissions, legal fees, title insurance, delinquent taxes, & surveying fees, should be included in its cost

Renovation and repair costs incurred by the company prior to the asset's use should be included in its cost

Net cash equivalent amount paid (or to be paid) for an asset Or when non-cash assets are used as payment, the fair value of the asset given/received Whichever can be more clearly determined (called the cash equivalent price) Assets can be acquired with cash, debt, and/or with the company's stock (at market value). ex: Invoice Price (-) Discount = Net Cash Invoice Price (+) Transportation Charges Paid (+) Preparation Costs Paid by Southwest = Cost of Asset (added to Asset account) Journal Entry: dr. Flight Equipment (+A) cr. Cash (-A)

Shorter-Term leases, are not reported on the balance sheet as liabilities and the assets are not included in fixed assets. ex: so airlines can lease new aircraft, gives them more flexibility in managing fleet size

Long-Term leases, the acquisition of assets that are reported on the balance sheet with the lease obligations, allowing for companies to take advantage of tax benefits

Non-Cash consideration (company's common stock or right given by company to seller to purchase company's goods or services at a special price), might be part of the transaction. When non-cash consideration is included in the purchase of an asset, the cash-equivalent cost (fair value of asset given or received) is determined. Journal Entry ex: dr. Flight Equipment (+A) cr. Common Stock (+SE) cr. APIC (+SE) cr. Cash (-A)

(# shares) x (market value) = X (# shares) x (par value) = Common Stock so, Common Stock - X = APIC PP&E - X = Cash Assets (+) PP&E (-) Cash Stock EQ (+) Common Stock (+) APIC ex: page 396 #3b

Company constructs asset instead of buying it from manufacturer Cost of the asset includes construction costs (Labor, Materials, Overhead, and interest on debt incurred during construction period, capitalized interest) Capitalizing labor, materials, and a portion of interest expense has the effect of: (+) increasing assets (-) decreasing expenses (+) increasing net income

Purchase Price Installation Costs Modifications to Buildings Transportation Costs ("Freight In") Real Estate Commissions Title Costs

Interest expenditures included in the cost of a self-constructed asset Portion of the interest incurred during the construction period Interest expense that is capitalized is recorded: dr. asset cr. cash when the interest is paid

Expenditures that are made after an asset has been acquired. Includes: cash outlays for ordinary repairs and maintenance, major repairs, replacements, and additions.

Expenditures to Maintain Normal Operating Condition Recorded as Expenses. Recurring, small amounts, do increase productive life of asset.

Expenditures that increase the productive life, operating efficiency, or capacity of an asset Not Expenses Expenditures are capitalized (added) to asset accounts Infrequent, large amounts of $ Ex: additions, major overhauls, complete reconditioning, major replacements & improvements

Capital Expenditures: Capitalizing expenses (additions & improvements) will increase assets and net income in the current year, lowering future years income by the amount of the annual depreciation. Revenue Expenditure: For tax purposes, expensing the amount (repair expenses) in the current period will lower taxes immediately.

Current income because it spreads a single period's operating expenses over many future periods as depreciation expense. It increases cash flows from operations by moving cash outflows from the operating section to the investing section of the cash flow statement.

Allocate cost of buildings and equipment over their useful lives Using the asset: depreciation expense each year Process of cost allocation, not a process of determining an asset's current market value or worth. When an asset is depreciated, the remaining balance sheet amount probably does not represent its current market value. On balance sheets subsequent to acquisition, the undepreciated cost is not measured on a market or fair value basis.

dr. Depreciation Expense cr. Accumulated Depreciation

Acquisition Cost (-) Accumulated Depreciation = Book Value The last net book value is equal to the estimated residual value at end of useful life

Allocating costs of intangible assets

1. Acquisition cost. 2. Estimated useful life to the company. 3. Estimated residual (or salvage) value at the end of the asset's useful life to the company

Expected service life of an asset to the current owner

Estimated amount to be recovered by the company at the end of an asset's useful life, minus the disposal costs

(Cost - Residual Value)/Useful Life Depreciable Cost: (Cost - Residual Value) Straight-Line Rate: (1/Useful Life)

Allocates the depreciable cost of an asset in equal periodic amounts over its useful life, most common. Depreciation expense is a CONSTANT amount each year. Accumulated depreciation increases by an EQUAL amount each year. Net book value decreases by the SAME amount each year until it equals the estimated residual value.

Shows computed amount of depreciation expense each year over the entire useful life of the asset

Method allocates depreciable cost of an asset over its useful life to total estimated productive output. Depreciable Cost/Estimated Total Production = Depreciation Rate per Unit of Production Then multiplied by the Actual Production for the period to get Depreciation Expense From period to period, depreciation expense, accumulated depreciation, and book value VARY directly with the units produced. In the units-of-production method, depreciation expense is a VARIABLE expense because it varies directly with production or use. If total estimated productive output differs from actual total output, final adjusting entry to depreciation expense should be for the amount needed to bring the asset's net book value equal to the asset's estimated residual value.

[(Cost - Residual Value) /Estimated Total Production] x Actual Production

Method that allocates the net book value (cost - accumulated depreciation), of an asset over its useful life based on a multiple of the straight-line rate, which gives more depreciation to early years and less to later years of an assets life. If an asset is considered to be more productive when it is newer, managers might choose this method to match higher depreciation expense with higher revenues in early years and lower depreciation expense with lower revenues in later years. This is an Accelerated Depreciation Method Based on applying a rate exceeding the straight-line rate to the asset's net book value over time. The rate is often double the straight-line rate and is termed the double-declining-balance rate. ex: if straight-line rate is 10% (1 ÷ 10 years) for a 10-year estimated useful life, the declining-balance rate is 20% (2 × the straight-line rate). Accumulated Depreciation increases over time. IMPORTANT DIFFERENCES FROM OTHER METHODS!! 1. Accumulated depreciation, not residual value, is included in the formula. Since accumulated depreciation increases each year, net book value decreases. The double-declining rate is applied to a lower net book value each year, resulting in a decline in depreciation expense over time. 2. As with the other methods, the net book value should not be depreciated below the residual value: Occasionally, before the end of the estimated useful life, if the annual computation reduces net book value below residual value, only the amount of depreciation expense needed to make net book value equal to residual value is recorded, and no additional depreciation expense is computed in subsequent years. More likely, in the last year of the asset's estimated useful life, whatever amount is needed to bring net book value to residual value is recorded, regardless of the amount of the computation. An asset should never be depreciated below the point at which net book value = residual value.

(Net Book Value) x (2/Useful Life) simply, (2*Book Value)/Useful Life Must check that it doesn't go past the Residual Value after each year, this check isn't built into the formula!!

Differences in depreciation methods rather than real economic differences can cause significant variation in reported net incomes

Straight-Line: (Cost − Residual Value) x 1/Useful Life Units-of-Production: [(Cost − Residual Value)/Estimated Total Production] x Annual Production Double-Declining-balance: (Cost − Accumulated Depreciation) x 2/Useful Life

The objective of financial reporting is to provide economic information about a business that is useful in projecting future cash flows of the business. Financial reporting rules follow generally accepted accounting principles.

The objective of the Internal Revenue Code is to raise sufficient revenues to pay for the expenditures of the federal government. Many of the Code's provisions are designed to encourage certain behaviors that are thought to benefit society (ex: contributions to charities are made tax deductible to encourage people to support worthy programs).

All taxpayers want to pay the lowest amount of tax that is legally permitted and at the latest possible date.

Both legal and ethical to maintain separate records for tax and financial reporting purposes. However, these records must reflect the same transactions.

IRS-approved way to calculate depreciation expense for their tax returns. However, it is not acceptable for financial reporting purposes.

1. Test for Impairment Net Book Value > Future Cash Flows = Yes NBV < FCF = No If Impaired, go to Step 2 2. Compute Impairment Loss NBV (-) FMV = Loss Then make an entry to write down the asset to fair value, if needed No write down if FMV > NBV

NBV < FCF

NBV > FCF

NBV > FMV dr. Loss cr. Accumulated Depreciation

NBV < FMV

NBV - FMV = Write Down

Depreciation must be recorded on the date of disposal for the amount of cost used since the last time depreciation was recorded. Needs 2 entries: 1. Record Depreciation Expense & Accumulated Depreciation up to Disposal Date 2. Record Disposal/Sale of Asset Cost of Asset and any Accumulated Depreciation at disposal date must be removed from accounts. Difference between Resources Received on Disposal of Asset and Book Value = Gain (or Loss) reported on the Income Statement. dr. Cash dr. Accumulated Depreciation cr. Asset also dr. Loss on Sale (if any) cr. Gain on Sale (if any) Compute Gain or Loss, depends on the sale, or if throwing away

Throw Away, no Gain or Loss

Depreciation is based on estimates: Estimated Residual (Salvage) Value Estimated Useful Life If the estimates are changed, the depreciation is revised for the rest of the useful life, but is not changed for past years!!

Cost of an Intangible Asset with a Definite Life is done by Amortization a Straight-Line basis. Most Intangibles have no Residual Value Amortization Expense recorded on Income Statement Intangible Assets reported on Balance Sheet as: Cost (-) Accumulated Amortization

Purchase a Patent and use for # of Years ex: Purchase Price/# of Years = Expense dr. Patent Amortization Expense (+E, -SE) cr. Patent or Accumulated Amortization (+XA, -A)

Intangible Assets with Indefinite Lives are not Amortized. Reviewed Annually for Possible Impairment of Value by first using Qualitative Factors to determine whether it is more likely than not that the fair value of the indefinite-life intangible is less than its carrying amount. Qualitative Factors include: negative effects due to increases in costs, decreases in cash flows beyond expectations, an economic downturn, or deterioration in the industry.

Internally generated, so not reported as an asset unless a business is purchased. Then the Purchase Price - Fair Value of Net Assets = Goodwill.

Technically valuable assets to the company but not usually reported on Balance Sheet

Exclusive rights, if purchased it is recorded at cost

Intangible Asset describing costs for computer software & web development

Typically Expensed Can't guarantee Future Cash Flows

Exclusive Right granted by the Federal Government for 20 years Typically granted to a person who invents a new product or discovers a new process. Recorded at Purchase Price If Developed Internally, Recorded at Registration & Legal Costs because GAAP requires immediate expensing of R & D Costs

Granted by the Government or a Business for a Specified Period & Purpose. Life of Franchise Agreement Depends on the Contract

Grant Permissions, sometimes Recorded on Balance Sheet as "Other Assets"

Companies develop raw materials and products from natural resources. Resources are depleted (physically used up).

When Acquired, Recorded with Cost Principle. As it's used up, Acquisition Cost must be apportioned among periods in which revenues are earned (Expense Principle). The units-of-production method is used to compute depletion.

Allocating natural resource's cost over exploitation period. Depletion of Natural Resource is how you get the Inventory Amount of Natural Resource Depleted is Capitalized as Inventory, not expensed. When Inventory is sold, COGS will be an expense on Income Statement.

dr. Inventory (+A) cr. Natural Resource (-A) or (Accumulated Depletion +XA, -A)

Although Depreciation is added in the Operating Section of the Statement of Cash Flows, depreciation is not a source of cash Depreciation is a deductible expense for income tax purposes.

(Net Book Value - New Residual Value)/Remaining Years = New Yearly Depreciation Expense