ACCT 2610 Lecture 14: PPE, Natural Resources, and Intangibles

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Accounting ACCT 2610
Lemayian Zawadi

Lecture 14-15: Reporting and Interpreting PP&E, Natural Resources, and Intangibles I. Long-Lived Assets A. Basics 1. Long-lived assets are tangible and intangible resources owned by a business and used in its operations over several years a. General types of long-lived assets • Tangible long-lived assets • Intangible long-lived assets 2. Intangible Long-Lived Assets a. Non-physical items that confer specific rights on the their owner b. Examples include: patents, copyrights, trademarks, franchises, goodwill, licenses 3. Tangible Long-Lived Assets a. Physical items that are classified as property, plant, and equipment or fixed assets b. There are three general types of long-lived assets • Land • Buildings, fixtures, and equipment • Natural resources B. Tangible Assets 1. Acquisition a. What costs are capitalized (put on balance sheet rather than expense immediately) b. The general rule is that all reasonable and necessary expenditures made in acquiring and preparing an asset for use should be recorded as the cost of the asset and capitalized c. Special discounts are subtracted from the acquisition cost of long-lived assets d. Expenditures capitalized as long lived assets: • Purchase price • Improvements • Sales taxes • Legal fees • Installation costs • Transportation fees e. A company might want to capitalize an expenditure rather than expense it to: • Increase current period net income • Allow the company to spread the expense over a longer period of time rather than recognize it all during the current period • An asset as a long term benefit, where depreciation expense is recorded in each time period f. Long lived assets can be purchased with: • Cash • Debt • Equity • Other non-cash considerations g. Long-lived assets can also be constructed • All expenditures associated with the construction of the asset are capitalized during the construction of the asset • E.g., labor, materials, and the interest incurred during the construction period 2. Post-Acquisition Expenditures a. Post-acquisition expenditures are ordinary repairs and maintenance, additions and improvements b. **General rule . . . • Expense the cost if it only benefits the current period • Capitalize the cost it if increases future benefits c. Ordinary repairs and maintenance expenditures (i.e., revenue expenditures): • Expenditures for the normal maintenance and upkeep of long-lived assets • Recurring in nature • Do not directly lengthen the useful life of the asset • Ordinary repairs and maintenance expenditures are expensed d. Additions and Improvements (i.e., capital expenditures) • Expenditures that increase the productive life, operating efficiency, or capacity of the asset • Increase the efficiency or life of the asset • Examples include: additions, major overhauls, complete reconditioning, major replacements, improvements • Additions and improvements are capitalized 3. Use of Tangible Assets a. Depreciation is the process of allocating the cost of a tangible asset over its productive life using a systematic and rational method b. Tangible assets with a limited useful life are depreciated • Represent the prepaid cost of a bundle of future services or benefits • Matching principle requires that a portion of the asset’s cost be allocated as an expense in the same period that revenues are generated by its use c. Tangible assets with unlimited useful lives are not depreciated d. Natural resources are depleted e. Intangible resources are amortized f. Depreciation is a process of cost allocation, NOT a process of determining an asset’s current market value or worth • After an asset is depreciated, the remaining balance sheet amount does not necessarily represent its current market value • After acquisition, the asset is not measured at fair market value (what the item could be sold for today) on the balance sheet • Cost of good determined by cost at purchase (historical value under GAAP) 4. Depreciation a. Record the journal entry in the following manner: • Dr. Depreciation Expense, Cr. Accumulated Depreciation • Depreciation expense is the amount reported on the income statement for each period • The accumulation of depreciation expense recorded since the acquisition date of the asset • Accumulated Depreciation is a contra-asset account, its companion account is the Property, Plant, and Equipment account b. For a long lived asset, the net book (carrying) value is calculated: • Acquisition Cost – Accumulated Depreciation = Net Book (carrying) value • Net value reported on the balance sheet, usually under “PP&E, net” c. To calculate depreciation expense you need 3 amounts: • Acquisition Cost • Estimated Useful Life to the company: management’s estimate of the asset’s useful economic life to the company rather than its total economic life to all users • Estimated residual (salvage) value at the end of the asset’s useful life: management’s estimate of the amount the company expects to recover upon disposal of the asset at the end of its useful life C. Cost Allocation Methods 1. Straight-Line a. Allocates the cost of the asset in equal periodic amounts over its useful life b. Most common depreciation method used, most steady for shareholders c. Could halve the useful life to decrease depreciation expense d. Can use a higher residual value to depreciate less fraudulently e. Assumes same depreciation each year f. To fraudulently lower their depreciation expense, company could
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