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Nov 7 Class Notes - WEEK 8 (Oct 28, Nov 4, 5, 7); Chapter 9 - COMM 2AA3

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Aadil Merali Juma

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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