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Chapter 9 - Long lived tangible/intangible assets
Terms in this set (68)
9-1 Define, classify, and explain the nature of long-lived assets
long-lived assets are those that a business retains for long periods of time for use in the course of normal operations rather than for sale. They may be divided into tangible assets (land, building, equip.) and intangible assets (including goodwill, patents, franchises)
9-2 Apply the cost principle to the acquisition of long-lived assets
-the acquisition cost of property, plant, and equipment is the cash-equivalent purchase price + all reasonable and necessary expenditures made to acquire and prepare the asset for its intended use. Expenditures made after the asset is in use are either expensed or capitalized as a cost of the asset
a) expenditures are expensed if they recur frequently, involve relatively small amounts, and do not directly lengthen the asset's useful life. These are considered ordinary repairs and maintenance expense
b) expenditures are capitalized as a cost of the asset if they provide benefits for one or more accounting periods beyond the current period. This category includes extraordinary repairs, replacements, and additions
9-3 Apply various depreciation methods as economic benefits are used up over time
- IN conformity with the matching principle, the cost of long-lived tangible assets (less any estimated residual value) is allocated to depreciation expense over each period benefited by the assets
-because of depreciation, the book value of an asset declines over time and net income is reduced by the amount of the expense
-common depreciation methods include straight-line (constant amt over time), units-of-production ( variable amt over time), and double-declining balance ( a decreasing amt over time)
9-4 Explain the effect of asset impairment on the financial statements
when events or changes in circumstances reduce the estimated future cash flows of a long-lived asset below its book value, the book value of the asset should be written down, with the amount of the write-down reported as an impairment loss.
9-5 Analyze the disposal of long-lived tangible assets
when assets are disposed of through sale or abandonment,
-record add'l depreciation arising since the last adjustment was made
-remove the cost of the old asset and its related accumulated depreciation
recognize the cash proceeds (if any)
-recognize any gains or losses when the asset's book value is not equal to the cash received
9-6 analyze the acquisition, use, and disposal of long-lived intangible assets
intangible assets are recorded as cost, but only when purchased. The costs of most internally developed intangible assets are expenses as research and development when incurred.
-intangibles are reported at book value on the Balance Sheet
-amortization is calculated at book value on the balance sheet
-intangibles with unlimited useful lives, including goodwill, are not amortized, but are reviewed for impairment
9-7 Interpret the fixed asset turnover ratio
the fixed asset turnover ratio measures the company's efficiency at using its investment in property, plant, and equipment to generate sales. Higher turnover ratios imply greater efficiency
9-8 Describe factors to consider when comparing companies' long-lived assets
companies in different industries require different levels of investment in long-lived assets. Beyond that, you should consider whether differences exist in
estimated useful lives,
and estimated residual values,
which can affect the book value of long-lived assets as well as ratios calculated using these book values and any gains or losses reported at the time of asset disposal
fixed asset turnover ratio
net revenue/ average net fixed assets
-dollars of revenue generated for each dollar invested in (tangible) fixed assets
-a higher ratio implies greater efficiency
1) for intangible assets, this is the systematic and rational allocation of the cost of an intangible asset over its useful life
2) for bonds payable, this involves allocating any premium or discount over the life of the bond
*amortizing will decrease net income on the income statement and decrease assets on the balance sheet
-amortization is spread on a straight line basis
amortization is reported as an expense
-journal : dr amortization expense
cr patents (intangible asset)
-trademarks and goodwill are not amortized, they have unlimited life
-all intangible assets are tested at least annually for possible impairment, if impaired, its book value is written down (reduced) to its fair value and the reduction is reported as an expense
to record a cost as an asset rather than an expense
a form of protection provided to the original authors of literary, musical, artistic, dramatic, and other works of authorship.
declining-balance depreciation method
allocates the cost of an asset over its useful life based on a multiple of (often two times) the straight-line rate
process of allocating a natural resource's cost over the periods of its extraction or harvesting
the portion of the asset's cost that will be used up during its life. it is calculated as asset cost - residual value, and it is allocated to deprecation expense throughout the asset's life
abbrev. for "earnings before interest, taxes, depreciation, and amortization," which is a measure of operating performance that some managers and analysts use in place of NET INCOME
infrequent expenditures that increase an asset's economic usefulness in the future, and that are capitalized
a contractual right ot sell certain products or services, use certain trademarks, or perform activities in a certain geographical region
goodwill (cost in excess of net assets acquired)
for accounting purposes, the excess of the purchase prices of a business over the market value of the business's assets and liabilities
occurs when the cash to be generated by an asset is estimated to be less than the carrying value of that asset and requires that the carrying value of the asset be written down
the limited permission to use property according to specific terms and conditions set out in a contract
tangible and intangible resources owned by a business and used in its operations over several years
shorthand term used to refer to :
assets - liabilities
ordinary repairs and maintenance
expenditures for the normal operating upkeep of long-lived assets, recorded as expenses
a right to exclude others from making, using, selling, or importing an invention
research and development costs
expenditures that may someday lead to patents, copyrights, or other intangible assets, but the uncertainty about their future benefits requires that they be expensed
residual value / salvaged value
estimated amount to be recovered, less disposal costs, at the end of the company's estimated useful life of an asset
straight-line depreciation method
allocated the depreciable cost of an asset in equal periodic amounts over its useful life
capitalized computer software and web development costs; an intangible asset
an exclusive legal right to use a special name, image, or slogan
units-of-production depreciation method
allocates the depreciable cost of an asset over its useful life based on its periodic output in relation to its total estimated output
the expected service life of an asset to the present owner
declining-balance depreciation methods are also called accelerated methods
helpful reminder 1
costs that benefit future period are CAPITALIZED as ASSETS. costs that benefit only the current period are recorded as EXPENSES
helpful reminder 2
declining-balance deprecation methods subtract accumulated deprecation, NOT residual value, from the asset's cost. For this reason, take extra care to ensure that you stop depreciation the asset when its book value equals its residual value
frequent mistake 1
deprecation does not represent a decline in the current value of an asset; declines in asset values are recorded as impairment losses, NOT depreciation. The purpose of deprecation is to allocate the cost of a long-lived asset to each period in which the asset is used to generate revenue
frequent mistake 2
to record an asset disposal, remove its cost and accumulated deprecation separately, rather than remove just its book value from the asset's account
define long-lived assets. What are the two common categories of long-lived assets?
Long-lived assets are business assets acquired for use over one or more years. These assets are not intended for resale, but are considered "productive" assets b/c they enable businesses to produce goods or services.
Two common categories are
1. Tangible assets : long-lived assets that have physical substance ( land, buildings, machinery, vehicles, office equipment, furniture). These assets are grouped into a single line on the BALANCE SHEET called property, plant, and equipment. because many long-lived tangible assets are fixed in place, they are also known as FIXED ASSETS
2. Intangible assets : long-lived assets have special rights but no physical substance. the existence of most intangible assets is indicated only by legal documents that describe their rights. compared to the tangible assets, intangible assets are less familiar. Things like brand names, trademarks, and licensing rights are included.
- the third category of long-lived assets that are depleted over time = natural resource assets (oil, gold, water)
under the cost principle, what amounts should be recorded as a cost of a long-lived asset?
Under the cost principle, all reasonable and necessary costs to acquire and prepare an asset for use should be recorded as a cost of the asset.
what amounts should be capitalized:
land - purchase cost, legal fees, survey fees, title search fee
building - purchase/ construction cost, legal fees, appraisal fees, architect fees
equipment - purchase/ construction cost, sales taxes, transportation costs, installation costs
-if a company incurs demolition, renovation, or repair costs before property, plant or equipment is used = additional costs also would be capitalized
what is the term for recording costs as assets rather than as expenses? describe how the decision to record costs as assets, instead expense, affects the balance sheet/ income statement?
Capitalizing cost is recording a cost as an asset rather than expense. this impact includes increasing ASSETS on the balance sheet and decreasing EXPENSES on the income statement.
waste mgmnt inc. regularly incurs costs to find new locations for landfill sites. what reasons support capitalizing these costs? what reasons support expensing these costs?
- reasons to capitalize the costs for new locations are the purchasing, surveying, title search fee all are costs that are usually capitalized and according to cost principle any cost that prepares an asset for use should be recorded.
- the reasons to expense these costs is that if there is no asset acquired, these are just costs incurred because there is no asset to make-up for it.
-Other costs that are expensed when incurred include insurance for fixed assets in use, interest on loans to purchase fixed assets and ordinary repairs and maintenance
distinguish between ordinary repairs and extraordinary repairs. How is each accounted for?
1. ordinary repairs and maintenance are expenditures for the routine maintenance and upkeep of long-lived assets.these are recurring, relatively small expenditures that do not directly increase an asset's usefulness. they are recorded as expenses in the current period and are matched to revenues, so ordinary repairs are sometimes called revenue expenditures
2. extraordinary repairs, replacements, and additions occur infrequently and involve large expenditures. they increase the asset's usefulness through enhanced efficiency, capacity or lifespan. because they increase the lifespan of tangible assets, they are added to the appropriate long-lived asset accounts. extraordinary repairs capitalize costs and are also called capital expenditures.
describe the relationship between the matching principle and accounting for long-lived assets
Depreciation is the allocation of existing costs that were already recorded as a long-lived asset, like a prepayment for future benefits. as the asset is used, those prepaid benefits are used up and the asset is decreased each period, which creates an expense. This is reported on the income statement and matched against the revenue generated by the asset.
-depreciation affects the income statement with the account, depreciation expense, which reports the depreciation of that current period.
-depreciation affects the balance sheet with the account - accumulated depreciation, which contains the current period's depreciation as well as prior periods.
why are different deprecation methods allowed?
Because companies own different assets and use them differently, they are allowed to choose from several different deprecation methods. these alternative deprecation methods produce different patterns of deprecation as represented by the depreciation amts recorded each year.
the amount of depreciation expense recorded in each year of an asset's life depends on the method that is used. that means that the amount of net income that is reported can vary, depending on the depreciation method used.
different deprecation methods can be used for different classes of assets provided they are used consistently over time so that financial statement users can compare results across periods.
-straight line method is preferred because it is the easiest to use and understand, and it does a good job of matching depreciation expense to revenues when assets are used
unit of production method is typical choice when asset use fluctuates significantly from period to period
declining-balance method apply best to assets that are most productive when they are new but quickly lose their usefulness as they get older
in computing deprecation, 3 values must be known or estimated. Identify and describe each.
1. asset cost - includes all the asset's capitalized costs, including the purchase cost, sales tax, legal fees, and other costs needed to acquire and prepare the asset for use.
2. useful life - an estimate of the asset's useful economic life to the company (not its economic life to all potential users). it may be expressed in terms of years or units of capacity.
Land is the only tangible asset that's assume to have an unlimited useful life. because of this, LAND IS NOT DEPRECIATED
3. Residual value - or salvage value, is an estimate of the amount the company will receive when it disposes of the asset.
what type of depreciation expense patter is used under each of the following methods and when is its use appropriate?
a. straight-line method
b. units of production method
c. the double declining balance method
a) straight - line method is used when the usage is expected to be the same each period.
the straight-line formula for estimating annual depreciation expense is:
(cost - residual value) x 1/ useful life
- in this formula, (Cost - residual value) is the total amt to be depreciated (depreciated cost).
the straight-line depreciation schedule have these characteristics:
1. depreciation expense is a CONSTANT amount each year
2. Accumulated Dep. increases by an EQUAL amount each year
3. Book value DECREASES by the same amount each year
b. units of production method
is when the amount of asset production varies significantly from period to period, and can be defined in terms of miles, products, or machine-hours, units of production formula is for estimating deprecation expense:
(Cost - residual value) x actual production this per. / estimated total production
-under the units-of-production method, the deprecation expense, accumulated deprecation and book value vary from period to period, depending on the number of units produced
c. declining-balance method
is used to report more depreciation expense in the early years of an asset's life when the asset is more efficient and less in later years as the asset becomes less efficient. because this method speeds up depreciation reporting, it is sometimes called Accelerated method and used less frequently.
the declining-balance method applies a depreciation rate to the book value of the asset at the beginning of each accounting period. the slight difference in the formula produces declining amounts of depreciation as the asset ages. because 2/ useful life rate is used in the formula, it doubles the straight-line rate and is also called "double" declining-balance method:
(Cost - accumulated deprecation) x 2 / useful life
*the beg. balance in acc. depreciation = 0,
but as years pass the additional depreciation is recorded and the acc. depreciation balance increases, causing the amount of double-declining depreciation expense to decline over time
*(when finding declining - find yr 1 begin with 0, then use that amount to find yr 2)
-because residual value is not included in the formula for the declining-balance method of computing depreciation expense, you have to make sure that an asset's book value is not depreciated beyond its residual value. if it goes below that, you must record a lower amount of depreciation so that the book value will equal the residual value
after merging with northwest airlines, delta airlines increased the estimated useful life and increased the estimated residual value of its flight equipment. all else equal, how will each of these changes affect delta's depreciation expense and net income?
Increasing the useful life of an asset decreases the amount of depreciation. also, increasing the residual value will decrease the depreciable cost of the asset. this will increase the amount of useful life the company has, and decreases the depreciation expense each year, increasing net income.
what is an asset impairment? how is it accounted for?
Asset impairment occurs when events or circumstances change causing the estimated future cash flow from a long-lived asset to fall below its book value.
If the assets estimated future cash flows are less than its book value, the book value should be written down to what the asset is worth (called fair value) with the amount of the write down reported as impairment loss
-impairment losses are classified as operating expense on the income statement and reported above the income from operations subtotal.
what is book value? when equipment is sold for more than book value, how is the transaction recorded?how is it recorded when the selling price is less than book value?
The gain or loss on disposal is calculated as the difference between the asset's selling price and its book value so
original cost - accumulated depreciation = book value
selling price - book value at disposal = loss/gain on disposal
*be sure to reduce both the asset and acc. depreciation accts for their full cost and accumulated depreciation (updated to the time of disposal)
distinguish between depreciation and amortization
Amortization is similar to depreciation because Amortization is reported as an expense each period on the income statement and also is subtracted directly from the applicable intangible asset accounts on the balance sheet. The difference is that amortization is used for intangible assets and bonds whereas depreciation is for tangible assets.
define goodwill. when is it appropriate to record goodwill as an intangible asset? when is its value decreased?
Goodwill is the excess of the purchase price of a business over the market value of the business's assets and liabilities. it encompasses things like favorable location, customer base, a great reputation and successful business operations. (intangible assets)
GAAP does not allow it to be reported as an intangible asset on the balance sheet unless it has been purchased from another company
how to capitalize expenditures
= net invoice price
+ transportation cost
= total cost
cash purchase journal entry
dr Equipment (+A)
cr Cash (-A)
credit purchase journal entry
dr Equipment (+A)
cr Cash (-A)
cr Note Payable (+L)
Depreciation journal entry
dr depreciation expense (+E, -SE)
cr acc. depreciation (+xA, -A)
the basic idea of depreciation is to match the economic benefit (asset cost - residual value) to the periods the asset will be used to generate revenue (useful life). residual value is considered when calculating depreciation b/c we want to leave some of the assets cost in the account.
this is because when disposed of, the business likely will get back some of the money initially paid, so the amount to be depreciated over the asset's life is the difference between its cost - residual value = depreciable cost
impairment loss journal entry
If the company estimated the book value was $663 mill and the fair value was estimated to be 600 mill, then the impairment loss is calculated as:
663 - 600 = (63 mill)
dr Loss on Impairment (+E, -SE)
cr equipment (-A)
disposal of tangible asset journal entry (loss)
dr Cash (+A)
dr Acc Depreciaiton (-xA, +A)
dr Loss on disposal (+E, -SE)
cr Buildings, etc. (-A)
disposal of tangible asset journal entry (gain)
dr Cash (+A)
dr Acc Depreciation (-xA, +A)
cr Gain on disposal (+R, +SE)
cr Building, etc. (-A)
J&J uses GAAP, Bayer uses IFRS. explain what complications might arise when comparing the property, plant and equipment of these two companies.
GAAP vs IFRS
GAAP: must record at cost, adjust for depreciation and impairment, do not record increases in value
R&D : expense all costs of researching and developing intangible assets
IFRS: choose between either cost or fair value, adjusts for depreciation and impairment, if using fair value, record increases in value
R&D: expense research costs but capitalize measurable costs of developing intangible assets
fixed asset turnover ratio
net revenue / average net fixed assets
indicates dollars of revenue generated for each dollar invested in fixed assets (long-lived tangible assets)
-a higher ratio implies greater efficiency
calculated by starting with net income + depreciation + amortization expense + interest + taxes
-allows analysts to conduct financial analyses without having to deal with differences in depreciation and amortization
cost of tangible asset
initial payment + renovations/installation costs = acquisition cost
book value - fair value = impairment loss
partial balance sheet
pp&e at cost - accumulated depreciation = pp&e net
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