Class Notes (807,463)
Canada (492,648)
Rotman Commerce (1,030)
RSM219H1 (86)

chapter 9

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University of Toronto St. George
Rotman Commerce
Alexander Edwards

CHAPTER 9: Reporting and Analyzing Long-lived Assets 1. Property, plant, and equipment and 1.1 Capital assets are long-lived assets acquired for use the operations of the business and are not intended for sale to customers. They are used in the production in sales of good and services for customers. 1.2 Capital assets may be tangible (with physical substance) or intangible (without physical substance). Intangible assets provide future benefits through special rights and privileges. They include patents, copyrights, goodwill, trademarks, and trade names franchises, licences, R&D (research and development cost). 1.3 Tangible capital assets are often subdivided into two classes: 1.3.1 Property, plant, and equipment. Land. Land improvements, such as driveways, parking lots, fencing, landscaping, and underground sprinkler systems. Buildings, such as stores, offices, factories, and warehouses. Equipment, such as store check-out counters, cash registers, coolers, office furniture, factory machinery, and delivery equipment. 1.3.2 Natural resources. Natural resources physically lose substance or deplete, as they are used. 2. Determining the Cost of property, plant, and equipment 2.1 Capital assets, including property, plants, and equipment, are recorded at historical cost in accordance with the cost principle of accounting: 1. The purchase price, including certain kinds of taxes and duties, less any discounts or rebates 2. The expenditures necessary to bring the asset to its required location and to make it ready for its intended use. 2.3 These costs are capitalized (recorded as property, plant, and equipment) rather than expensed if it is probable that the company will receive an economic benefit in the future from the asset and this benefits can be measured.  Operating expenditures: cost that benefit only the current period are expensed. - Operating expenditures to maintain an asset in its normal operating condition that often recur, although not always annually.  Capital expenditures: cost that benefit future pa are included in a long-lived asset account  Capital expenditures after accusation include cost that increases the life of an asset or its productivity and efficiency. These customer really larger than property expenditure and a current less frequently 2.5 Application of the cost principle to the components of property, plant, and equipment 2.5.1 The cost of land includes the cash purchase price, closing costs such as title and legal fees, and accrued property taxes and other liens on the land assumed by the purchaser. All the costs that come from preparing the land for use are also debited to the land account. Such costs include clearing, draining, filling, and removing old structures. 2.5.2 The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use. These improvements have limited useful lives and their maintenance and replacement are the responsibility of the company. Land improvements are recorded separately from land because, unlike land, they wear out over time, and must be amortized as a result. 2.5.3 Costs related to the purchase of a building include the purchase price and closing costs. Costs to make the building ready for its intended use consist of expenditures for remodeling rooms and offices and replacing or repairing the roof, floors, electrical wiring, and plumbing. Costs related to 1 construction of a building include the contract price plus payments made for architect’s fees, building permits, and excavation costs. In addition, interest costs incurred to finance the project are included in the cost of the asset when a significant period of time is required to get the asset ready for use. 2.5.4 The cost of equipment includes the cash purchase price, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit. Motor vehicle licenses and accident insurance on company trucks and cars are expensed as incurred, because they represent annual recurring expenditures and do not benefit future periods. These cost will not be benefit for only the current period, so they are not expenses, instead their benefit will be over a long future period so the cost are capitalized that is they are recorded as capital assets. 2.6 When capital assets are purchased as a group for a single price, it is known as a basket purchase. The total cost is allocated to the individual assets based on their relative fair market values. 3. Amortization 3.1 Amortization is the allocation of the cost of a capital asset to expense over its useful (service) life in a rational and systematic manner. 3.2 Cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle. 3.3 Amortization is a process of cost allocation, not a process of asset valuation. 3.4 The net book value (cost less accumulated amortization) of a capital asset may differ significantly from its fair market value. 3.5 Accumulated amortization represents the total cost of a capital asset that has been charged to expense; it is not a cash fund. 3.6 A decline in revenue producing ability may occur because of: 3.6.1 Physical factors such as wear and tear. 3.6.2 Economic factors such as obsolescence, which is the process of becoming out of date before the asset physically wears out. 4. Amortization Methods 4.1 The calculation of amortization expense is based on three factors: 4.1.1 Cost. 4.1.2 Useful life (service life) is an estimate of the expected productive life of the asset. Useful life may be expressed in terms of time, units of activity, or in units of output. 4.1.3 Residual value (salvage value) is an estimate of the asset’s value at the end of its useful life. 4.2 There are three common methods of amortization: straight-line, declining-balance, and units-of-activity. 4.2.1 Under the straight-line method, amortization is the same for each year of the asset’s useful life. The formula for calculating annual amortization expense is amortizable cost (cost less residual value) divided by useful life. The straight-line method is simple to apply, and it matches expenses with revenues appropriately when the use of the asset is reasonably uniform throughout service life. If an asset is acquired part-way through the year, the amortization is prorated for the time the asset was in use during the year. 4.2.2 The declining-balance method produces a decreasing annual amortization expense over the useful life of the asset. Annual amortization expense is calculated by multiplying the net book value at the 2 beginning of the year by the constant straight-line amortization rate. This rate is often increased by a declining-balance multiplier (e.g., 1, 1 ½, 2, 3). The method is compatible with the matching principle in that the higher amortization expense in early years is matched with the higher benefits received in these years. If an asset is acquired part-way through the year, the amortization is prorated for the time the asset was in use during the year. 4.2.3 Under the units-of-activity method, instead of expressing the life as a time period, useful life is expressed in terms of the total units of production or use expected from the asset. Annual amortization expense is calculated by multiplying amortization cost per unit by the units of activity during the year. This method is not nearly as popular as the straight-line method because it is often difficult to make a reasonable estimate of total activity. If an asset is acquired part-way through the year, the amortization is unaffected, since the units of activity already reflect the time the asset was in use during the year. It is used for 1) factory production where units of outputs or machine hours are used 2) it used for the delivery equipments ( the amount of Km that is used) 3) airplanes ( hours of used). These methods are not suitable for building furniture as they depreciate over time and not with the usage. Choose the methods of amortization methods based on the pattern of the assets so 1) capital assets that generates consistent revenue overtime should use the straight line methods. 2) More productive assets that generate great revenue in the early years of their life should use the declining methods. 3) If the usage of the assets varies greatly or substantially over time then use the unit of activity method. 4.3 Amortization and Income Tax 4.3.1 Canada Customs and Revenue Agency (CCRA) allows the taxpayer to deduct amortization expense when calculating taxable income. 4.3.2 For income tax purposes, taxpayers must use the single declining-balance method, applied to a group of like assets. CCRA specifies the rates that must be used for each class of assets. There are certain other rules (e.g., ½ year rule) and restrictions that must be followed when applying this method, termed capital cost allowance (CCA). 5. Revising Periodic Amortization 5.1 If physical or economic factors indicate that annual amortization is inadequate or excessive, a change should be made. The residual or the salvage value is the dollar amount that you can get from the assets if u try to sale it that’s is the market value after 5 years. 5.2 Revisions of periodic amortization are considered to be changes in estimates and are made in current and future years but not retroactively. 5.3 To determine the new annual amortization expense, the asset’s amortizable cost at the time of the revision (net book value less residual value) is divided by its remaining useful life. 6. Expenditures During Useful Life 6.1 Ordinary repairs are costs incurred to maintain the operating efficienc
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