LECTURE 8 COMM 2AA3
Chapter 9: Reporting and Interpreting Property, Plant and Equipment; Natural
Resources; and Intangibles
October 28, Nov 4, 5, 7 2013
Long-Lived Assets
Assets that are actively used in operations to generate future benefits beyond one year
Can be classified into tangible and intangible assets
Tangible Assets
Resources that have physical substance (a definite size and shape); used in the operations of a business and not intended for
sale to customers
Also called “Chattel”
Also called – property, plant and equipment; fixed assets; capital assets; operational assets
Includes – land, amortizable assets (building, equipment etc) and natural resources (mineral deposits, timber)
o Land – eg/ mining but doesn’t typically depreciate
Except for land, all tangible assets are subject to depreciation or depletion (natural resources)
Other Long-Lived Assets
o Constructed assets
o Leased assets
o Asset Retirement Obligations
Measurement – tangible assets are measured at acquisition cost; cost includes the cash equivalent purchase price plus all
reasonable and necessary expenditures made to acquire and prepare the asset for its intended use (can differentiate expense
from cost)
o Acquisition is amount paid to acquire good; part of historical cost (which includes costs to prepare goods)
o Expense – when object is operational
o Acquisition Cost – Buildings
Purchase price
Architectural fees
Renovation and repair costs and cost of permits (before move-in; if already operational then renovation –
expense)
Legal and realty fees
Title fees
Excavation and construction costs
o Acquisition Cost – Equipment
Purchase price – including taxes
Installation costs
Modification to building necessary to install equipment – eg/ supply power, build new room for equipment
Transportation costs
o Acquisition Cost – Land
Purchase price
Real estate commissions
Title insurance premiums
Delinquent taxes
Surveying fees
Title search and transfer fees
Land is not amortizable
o Acquisition for non-cash consideration – record at current market value of the consideration given, or the current
market value of the asset acquired, whichever is more clearly evident
Purchase item for $100; cash $20, N/P $80 clear value of item is $100
Purchase item for $100; cash $20, issue 80 shares at a face price of $1, but a market value of $2 unclear
value of equipment purchases
Face price – when company gives shares, amount company sells shares for
Market price – market know prices will go up, amount buyers willing to pay for shares
o Other Long Lived Assets
Constructed assets – creation of new asset, no fine timeline
Leased assets – operational lease (I/S as an expense), capital lease (balance sheet as an asset); IFRS has 4
rules to determine whether it is an asset or expense
1 LECTURE 8 COMM 2AA3
Asset Retirement Obligations – eg/ mining, lead and harmful chemicals left; pay to restore land – ridding of
asset, there is an obligation; have to record this cost when recording the asset (before cost even is incurred –
will be a gain or loss afterward to account for difference between estimate and reality)
o Acquisition as a Basket Purchase – the total cost of a combined purchase of land and building is separated on the basis
of their relative market values
Two methods to determine value recorded for each item – Relative Appraised Value and Residual Value
One tangible, one intangible
Eg/ TV and warranty
Eg/ Buy a house, get the land with it; eg/ buy TV, get Blu-ray player
Eg/ On Jan 1, WestJet purchased land and building for $300,000 cash; the appraised values are building,
$189,000 and land $126,000. How much of the $300,000 purchase price will be charged to the building and
land accounts
189 + 126 = 315
Appraisals are subjective
Method 1 – Relative Appraised Value
o Building = 189,000/315,000 x 300,000
o Land = 126,000/315,000 x 300,000
Eg/ For a TV and Blu-ray as a deal for $200. The TV separately costs $170 and Blu-ray separately costs $70.
How much of the $200 that you paid is assigned to the TV and Blu-ray?
Method 2 – Residual Value
o Cannot argue that the value of this purchase is in the TV
o TV = $170
o Blu-Ray = $200 - $170 = $30 (residual)
Subsequent Costs (after asset has been readied for intended use)– two types of expenditures; can be used if increases
productive life or capacity
o Capital Expenditures – increase the productive life (useful life), operating efficiency or capacity of the asset (B/S)
o Revenue Expenditures – maintain the productive capacity; operating expense (I/S)
Repairs, Maintenance and Betterments
o Revenue expenditure – goes into I/S, operating expense
o Capital – B/S
Capital and Revenue Expenditures
o Capital Expenditure – eventually comes into I/S as depreciation; income higher initially
o Revenue Expenditure – directly into I/S as an expense
o Many companies have policies expensing all expenditures below a certain amount according to the materiality
constraint
Depreciation
o Non-cash flow item
o Allocating to expense the cost of an asset over its useful life in a rational and systematic manner, in accordance with
the matching principle
o Process of cost allocation, not asset valuation
Taking cost from balance sheet into income statement over its useful life (over time, not instantaneously) –
process of cost allocation from B/S to I/S
Value of asset decreases
o Not a cash fund
2 LECTURE 8 COMM 2AA3
o Depreciation Methods
Straight-line
Declining-balance
Sum-of-years- digits
Units-of-activity
o Factors in Calculating Depreciation
Cost – original purchase price
Useful life – original life that asset is expected to last; can change
Salvage Value – amount expected to be received after useful life
Terminal salvage value (TSV) – at the end of its life used in this course
Current salvage value (CSV) – currently
Depreciable Cost = Cost – Salvage Value
o Straight Line Method – depreciation is constant for each year of the assets useful life
Annual Depreciation = Depreciable Cost/Useful Life
=1/UL x (C-SV)
= Straight line depreciation rate x (Amortizable or depreciable cost)
o Declining Balance Method – accelerated depreciation method; result in more depreciation in early years and less in
later years
Annual Depreciation = Beginning book value x depreciation rate
Rate = 1/UL applied to book value
Rate = 1.5 / UL = 150% declining balance method
Rate = 2/UL = Double declining balance method
Difference from straight line method – applying rate to book value, not amortizable cost
o Sum-of-the-years-digits – accelerated depreciation method
Annual depreciation in first year = Depreciable cost x (n/SYD)
n = useful life in year
SYD = [n * (n+1)]/2
n in numerator decreases by one for each subsequent year
Refer to spreadsheet for eg
o Units of Activity
Useful life is expressed in terms of the estimated total units of production or use expected from the asset
Eg/ Calculate the annual depreciation expense for the following asset:
Cost $100,000
Useful Life 5 Years
Salvage Value $20,000
Estimated Total Output 1,000,000 units
Annual Output
Summary of Results
Comparison – Income Statement
o The declining-balance and SYD methods result in
Higher depreciation expense in the early years, compared to straight-line – thus lower income and tax liability
Lower earnings in the early years and higher earnings in the later years, compared to the straight line method
Changes in Estimates – changes in the assumptions about the assets useful
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