Class Notes (811,169)
Canada (494,539)
Commerce (1,859)

Accounting - Chapter 9&10 Notes.docx

18 Pages
Unlock Document

McMaster University
Emad Mohammad

CHAPTER NINE: REPORTING AND INTERPRETING PROPERTY, PLANT AND EQUIPMENT; NATURAL RESOURCES; AND INTANGIBLES 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  Chattels: long-lived assets (items such as chairs, tables, ovens, equipment, car) Tangible Assets  Resources that: o Have physical substance (a definite size and shape) o Are used in the operations of a business o Are not intended for sale to customers  Tangible assets help generate revenue but not for selling to customers  If going to resell to customer they are called inventory  Ex. pizza oven makes pizza but do not sell, delivery truck  Also called: o Property, plant and equipment o Fixed assets o Capital assets o Operational assets  Includes land, amortizable assets (building, equipment, etc.) and natural resources (mineral deposits and timber)  Except for land all tangible assets are subject to depreciation or depletion (natural resources) Intangible Assets  Rights, privileges and competitive advantages that result from ownership of long-lived assets that do not possess physical substance  Includes: patents, copyrights, trademarks, franchises, goodwill  Give advantage over competition  Hard to measure  Goodwill only comes about if sell company: o Goodwill (intangible asset): if paid more than net assets for company o Negative goodwill (a gain): if paid less than net assets  Trademark is recorded on balance sheet at acquisition cost  Acquisition cost: cost of asset is all the costs to acquire it and prepare it for use  Payments before asset has started operating is called a cost  Payments after asset has started operating is an expense  Ex. insurance that you pay for asset to reach you is a cost but the insurance after it is running is an expense  Some intangibles are subject to amortization Measurement  Tangible assets are measured at acquisition costs  Cost includes: o Cash equivalent purchase price o All reasonable and necessary expenditures made to acquire and prepare asset for intended use Acquisition Cost  Buildings: o Purchase price o Architectural fees o Renovation and repair costs o Costs of permits o Legal and realty fees o Title fees o Excavation and construction costs  Equipment: o Purchase price (including taxes) o Installation costs o Modification to building necessary to install equipment (ex. if cannot fit through door) o Transportation costs  Land: o Purchase price o Real estate commissions o Title insurance premiums o Delinquent taxes o Surveying fees o Title search and transfer fees o (Not amortizable) Acquisition for Noncash Consideration  Record at: o Current market value of consideration given o Current market value of asset acquired o (Whichever is more clearly evident)  Ex. Purchased building for $20,000 cash and issued a Notes Payable for $50,000  Total consideration is $70,000 (this is very clear)  Ex. Paid $20,000 cash and issued 50,000 common shares with a face price of $1 and a market value of $2  What would be the value of the building?  (50,000 x 2 + 20,000) = $120,000  Building would be recorded at $120,000 Other Long-Lived Assets  Constructed assets: building the asset (ex. hotel, apartment)  Leased assets: o Operational lease (expense) o Capital lease (asset)  Asset Retirement Obligations (ARO) o Ex. if you are going to mine for minerals it is possible that after the resources are depleted you will have to restore the land o Have to predict cost of planting trees, fixing land etc.  (Only have to know definitions – will be covered in advanced courses) Acquisition as a Basket Purchase  Total cost of a combined purchase of land and building is separated on the basis of their relative market values Relative Appraised Value Method Ex. On January 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? (1)Total price: $300,000 Individual price: 126,000 +189,000 = 315,000 (2)Land (126,000): 126,000/315,000 x 300,000 = 120,000 (3)Building (189,000): 189,000/315,000 x 300,000 = 180,000 Residual Value Method Ex. You bought a TV and a Blue Ray for $200. Separately, the TV costs $170 and the Blue Ray costs $70 (1)TV = 170 Blue Ray = 200 – 170 = 30 (2)Blue Ray is less significant so is valued at a lower price Subsequent Costs  Two types of expenditures: 1. Capital expenditures: o Increase the product life, operating efficiency or capacity of the asset o Operational capacity: can produce more per hour o Creating capacity: were able to produce 10,000 iPhones but can now produce 10,000 iPhones and 10,00 iPads 2. Revenue expenditures: maintain productive capacity of the asset Repairs, Maintenance and Betterments Type of Capital or Identifying Characteristics Expenditure Revenue - Maintains normal operating condition Ordinary repairs Revenue - Does not increase productivity and maintenance - Does not extend life beyond original estimate Extraordinary Capital - Major overhauls or partial replacements repairs - Extends life beyond original estimate - Increases productivity Betterments Capital - May extend useful life - Improvements or expansions Capital and Revenue Expenditures Financial Statement Effect Current Current Treatment Statement Expense Income Taxes Capital Balance sheet Deferred Higher Higher Expenditure account – debited Revenue Income statement Currently Lower Lower Expenditure account – debited recognized  Many companies have policies to expense all expenditures below a certain amount (according to materiality constraint)  If take expense now  income is lower  If take expense later (deferred)  income will be higher  Higher/lower income will not effect taxes paid to the CRA  Capital cost allowances: tells you exactly how an item can be depreciated  Ex. A computer can be depreciated in one year  Ex. A building built in the 1920s depreciates 20% per year  Subsequent costs can qualify as a capital expenditure but the company might take it as a revenue expenditure  This depends on whether or not they are envoking the materiality principle  Can take revenue expenditure even if it is a capital expenditure only if they are envoking the materiality principle Depreciation  Allocating to expense the cost of an asset over its useful life in a rational and systematic manner  In accordance with matching principle  Process of cost allocation not asset valuation  Not a cash fund  Valuation: what the market is willing to pay for the asset  Allocation: what you decide should be the value of the asset  Depreciation is allocation  Selling of the asset is valuation Depreciation Methods  Four methods of depreciation: (1)Straight-line: used in accounting (IFRS) (2)Declining-balance: used in CRA (3)Sum-of-years’-digits: never used (4)Units-of-activity: never used  Calculating depreciation depends on: o Cost: initial cost of asset o Useful Life: original estimate of how long you think the asset will last (your opinion) o Salvage Value: your opinion on how much you will get for the asset after its useful life  Depreciable cost = Cost – Salvage Value  Over the useful life all the methods will give the same answer Straight Line Method  Depreciation is constant for each year of the asset’s useful life  Annual Depreciation Expense = (Cost – Salvage Value)/Useful Life = Depreciable Cost/Useful Life  Depreciation Rate = 1/Useful Life  Ex. An item with a useful life of 5 years has a depreciation rate of 20%  Ex. If an asset has a depreciation rate of 10% it has a useful life of 10 years Declining Balance Method  An accelerated depreciation method  Accelerated: result in more depreciation in early years and less in later years  Annual depreciation = (Beginning book value) x (Depreciation rate)  Same rate as straight line = 1/(Useful Life)  Depreciation = (1/Useful Life) x (Beginning book value)  Beginning book value = Cost – Accumulated Depreciation  Beginning book value keeps decreasing with each passing year  Rate is a declining balance (ex. 1.5/Useful Life = 150% declining balance rate)  Most common: 2/Useful Life = double declining balance rate Ex. An asset has a 40% rate under the double declining balance rate. What is it’s useful life?  2/Useful Life = 40% Useful Life = 5 years Sum-Of-The-Years-Digits  Accelerated depreciation method  Annual depreciation in first year = Depreciable cost x (n/SYD) o n is the useful life for that year o SYD = [n*(n+1)]/2 o n in the numerator decreases by one for each subsequent year  There is a new rate for every year o Year one: 5/15 o Year two: 4/15 o Year three: 3/15 Units of Activity  Useful life is expressed in terms of the estimated total units of production or use expected from the asset Ex. 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: Year Output 1 200,000 2 300,000 3 400,000 4 100,000 5 0 Summary of results: Year Straight Line Double Declining Sum of Years 1 16,000 40,000 26,667 2 16,000 24,000 21,333 3 16,000 14,400 16,000 4 16,000 1,600 10,667 5 16,000 - 5,333  Straight line method is the same every year  Double declining is more in the beginning year then less  SYD is more accelerated because 5…5+4…5+4+3… etc.  All five years will add up to 80,000 no matter what method is used Comparison – Income Statement  Declining-balance and SYD methods result in higher depreciation expense in early years compared to straight line  Will also result in: o Lower earnings in early years o Higher earnings in later years Changes in Estimates  Changes in assumptions about asset’s useful life and salvage value  When change in estimate is required: change is made in current and future years but not to prior periods  Revised depreciation is calculated using the Net Book Value  A changed statement is no longer reliable  Statements are only restated if an auditor requires them to be by law as result of: o Fraud o Gross negligence  All shareholder’s have now made investment decisions based on incorrect information  People will lose trust in company and stock will most likely drop Ex. On January 1, 2001 ABC purchased a truck for $40,000 with an estimated useful life of 6 years and salvage value of $10,000. On December 15, 2004, BC revised its estimate of useful life to 8 years and of salvage value to $5,000. Calculate the depreciation expense for 2004 assuming ABC uses the straight-line method to amortize the truck.  Estimate was changed before making the financial statements  New cost is what you started the year with: Book Value on January 1  Depreciation of 5,000 a year for three years so: 40,000 – (3 x 5,000) = 25,000  So 25,000 is the new cost  New salvage value: 5,000  New useful life: 8 years total – 3 years used = 5 years Depreciation expense for 2004 (after change): (New Cost – New Salvage Value)/(Remaining Useful Life) = (25,000 – 5,000)/5 = $4,000 Asset Impairment  Impairment is the loss of a significant portion of the utility of an asset through: o Casualty (damaged) o Obsolescence (outdated) o Lack of demand for asset’s services (kind of like obsolescence)  Impairments can be temporary (lose value of asset for a while and then it comes back up)  Loss is recognized when assets suffers permanent impairment (no chance of it coming back)  Impairment Loss = Net Book Value – Fair Value o Fair Value < NBV  write it off o Fair Value > NBV  leave it  Fair value: what the market will pay you for the asset Adjusting Entry: Ex. You have DVDs that the market will pay you 90,000 for. Impairment loss 90,000 DVD inventory 90,000 Disposal of Property, Plant and Equipment  Four steps must be followed to record the disposal of PPE: (1)Update the depreciation (2)Calculate the net book value (3)Calculate the gain or loss (4)Record the disposal  Disposal means selling the asset (not throwing it away)  Assets are tied to accumulated depreciation  Have to get rid of the asset and it’s accumulated depreciation Dr. Cash Dr. Accumulated Depreciation Cr. Equipment Ex. XYZ Inc. sold the following to machines in 2005: Machine A Machine B Cost $84,000 $60,000 Purchase date 7/1/2001 1/1/2002 Useful life 8 years 5 years Salvage value $4,000 $3,000 Date sold 7/1/205 8/1/2005 Sales price $37,000 $22,000 Both Assets are amortized using the straight-line method.  Even though depreciation expense is an item that is an adjusting entry (done at end of year) have to make entry for depreciation expense mid-year because the asset is being sold Machine A Depreciation expense for 2005 = [(84,000 – 4,000)/8] x (6/12) = 5,000 July 1 Depreciation expense 5,000 Accumulated depreciation – Machine A 5,000 Book value as of July 1, 2005 = 84,000 – (10,000 x 4) = 44,000 Gain (loss) on disposal = 37,000 – 44,000 = 7,000 Cash 37,000 Accumulated Depreciation – Machine A 40,000 Loss on Disposal 7,000 Machine A 84,000 Machine B Depreciation expense for 2005 = [(60,000 – 3,000)/5] x (7/12) = 6,650 Aug 1 Depreciation expense 6,650 Accumulated depreciation – Machine B 6,650 Book value as of Aug 1, 2005 = 60,000 – (11,400 x 3 + 6,650) = 19, 150 Annual depreciation expense = 60,000 – 3,000/5 = 11,400 Gain (loss) on disposal = 22,000 – 19,150 = 2,850 Cash 22,000 Accumulated Depreciation – Machine B Machine B 60,000 Gain on disposal 2,850 ***Need to know for this chapter**** • Methods of depreciation • How to change an estimate for the current years and future years • How to sell an asset • Theory: o Which one gives accelerated method o Which give more expenses in beginning years o More income in beginning years o More taxes in beginning years o How all me
More Less

Related notes for COMMERCE 1BA3

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.