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FINAL EXAM STUDY NOTES (Ch9,10,11,12) -COMM 2AA3 Exam date: Dec 11, 2013
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Department
Commerce
Course
COMMERCE 1BA3
Professor
Aadil Merali Juma
Semester
Fall

Description
EXAM STUDY NOTES COMM 2AA3 Quicknotes – Final Exam December 11, 2013 Chapter 9: Reporting and Interpreting Property, Plant and Equipment, Natural Resources and Intangibles  Long-Lived Assets – assets actively used in operations to generate future benefits beyond one year; tangible and intangible 1. Tangible Assets – resources that have physical substance (definite size, shape); not intended for sale;  PP&E, fixed assets, capital assets, operational assets, chattel  Includes – land, amortizable assets(building, equipment etc), natural resources; constructed assets, leased assets, asset retirement obligations o Leased assets – operational lease (I/S expense) or capital lease (asset B/S) o Asset Retirement Obligations – eg/mining releases harmful chemicals,have to pay to restore land; record cost when recording asset (gain or loss to account for difference between estimate and reality)  Subject to depreciation or depletion (exception: land)  Measured at acquisition cost (cash equivalent purchase price plus all reasonable and necessary expenditures made to acquire and prepare asset for use)  Acquisition Cost includes: o Buildings – purchase price, architectural fees, renovation and repair, permits, legal and realty fees, title fees, excavation and constructed costs o Equipment – purchase price, installation costs, modification necessary for equipment installment, transportation costs o Land – purchase price, real estate commissions, title insurance premiums, delinquent taxes, surveying fees, title search and transfer fees o Non-cash consideration – record atcurrent market value of i) the consideration given or ii) the asset required – whichever is more clearly evident o Basket Purchase – total cost of a combined purchase is separated on relative market values  Relative Appraised Value Method – (appraised value of item 1/appraised value of both items) x purchase value  Residual Value Method – total – value of item 1 = value of item 2  Subsequent Costs – costs incurred after asset has been readied for use o Capital Expenditures – increases the productive life, operating efficiency or capacity of the asset o Revenue Expenditures – maintain the productive capacity Financial Statement Effect Treatment Statement Expense Current Income Current Taxes Capital Expenditure B/S (debit) Deferred Higher Higher Revenue Expenditure I/S (debit) Currently Lower Lower o Repairs, Maintenance and Betterments Type of Expenditure Capital or Revenue Identifying Characteristics Ordinary repairs and Revenue 1. Maintains normal operating condition maintenance 2. Does not increase productivity 3. Does not extend life beyond original estimate Extraordinary Repairs Capital 1. Major overhauls or partial replacements 2. Extends life beyond original estimate Betterments Capital 1. Increase productivity 2. May extend useful life 3. Improvements or expansions o Many companies have policies expensing all expenditures below certain amount (materiality constraint)  Depreciation o Allocating the cost of an asset over its useful life to expense; rational and systematic manner (matching principle); from B/S to I/S o Cost allocation; not asset valuation o Non-cash flow item o 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 Amortization x Depreciable Cost o Declining Balance Method – accelerated depreciation method; apply depreciation rate to BV; more depreciation in early years, less in later years; based on declining BV (cost less acc. dep.), depreciation rate remains constant  Rate = 1/UL  Rate = 1.5/UL  150% declining balance method  Rate = 2/UL  double declining balance method o Sum-of-years-digits Method – accelerated depreciation method  Annual Depreciation in year n = Depreciable cost x (n/SYD)  n = useful life in year; each year, n in numerator decreases by 1  SYD = [n*(n+1)]/2  remains constant o Units of Activity Method – expressed in terms of the estimated total units of production or use expected from the asset; applies to natural resources (units of activity = estimated total capacity of resource)  Annual Depreciation Expense = Depreciable Cost x (Units of Activity/Estimated Total Units of Activity) o Declining-Balance and SYD compared to Straight Line Method – higher depreciation expense and lower earnings in early years; higher earnings in later years  Changes in Estimates – changes in the assumptions about the assets useful life and salvage value o Originally recorded at date of acquisition; change is recorded in current and future periods, not in prior periods o Revised depreciation is calculated using the net BV at the time of the change in estimates o Apply to entire year when change is found o Depreciation Expense After Change = (New Cost – New Salvage Value)/Remaining Useful Life  Asset Impairment – loss of a significant portion of the utility of an asset through i) casualty ii) obsolescenceiii) lack of demand for the assets services o Recognize when an asset suffers permanent impairment o Impairment Loss = Net Book Value – Fair Value  Disposal of PP&E o Four Steps to Record Disposal 1. Update depreciation (if mid-year, record for fraction of the year) 2. Calculate the net book value – BV = Cost of Asset – Acc Dep 3. Calculate the gain/loss – gain if Proceeds > BV; loss if Proceeds < BV 4. Record the disposal – debit acc dep, debit cash, credit asset, debit loss or credit gain account  Natural Resource – non-current asset presented at cost less acc dep o Total Cost of Asset = Cost of Acquisition + Exploration + Development 1 EXAM STUDY NOTES COMM 2AA3 o Depletion calculated by units of production method – (Acquisition and Development Cost – Residual Value)/Estimated Recoverable Units 2. Intangible Assets  Involve rights, privileges and competitive advantages that result from ownership of long-lived assets; do not possess any physical substance s  Often difficult to determine useful life  Usually acquired for operational use  Record at current cash equivalent cost (including purchase price, legal fees and filing fees)  Definite Life – amortize over shorter economic life or legal life; GAAP rules; straight line method  Indefinite Life – not amortized; tested annually for possible impairment (BV reduced to fair value if impaired)  Goodwill – occurs when one company buys another company; only purchased goodwill is an intangible asset; the amount that purchase price exceeds fair market value of new identifiable asset acquired; indefinite life  Trademarks – a symbol design, or logo associated with a business; no record asset cost for internally developed; purchases trademarks recorded at cost; typically do not depreciate  Patents – exclusive rights granted by federal government to sell a manufactured invention; depreciable o Cost = Purchase Price + Legal Cost to Defend o Amortize cost over the shorter of useful life or 20 years o R&D that result in a patent are normally expensed as incurred  Copyrights – exclusive rights granted by the federal government to protect artistic or intellectual properties o Legal Life = Life of Creator + 50 Years  Franchises – legally protected rightto sell products or service according to specific terms and conditions; purchase price is an amortizable intangible asset  Licensing Rights – limited permission to use a product or service according to specific terms and conditions  Technology – includes a company’s website and any computer programs written by its employees  Research and Development Expenses – if intangible asset is developedinternally, recorded as R&D expense o Development costs can be deferred to future accounting periods, recorded as assets and amortized over time if deferral criteria is met Chapter 10: Reporting and Interpreting Current Liabilities Financing a Business  Finance the acquisition of assets by: o Debt (liability) o Equity (financing by owners; private (share capital) and public (common shares))  Capital Structure – the mix of debt and equity  Companies choose debt to finance businesses over equity o Debt financing – cheaper but riskier than equity  Financial Leverage – owners can potentially increase the return on their investments when they finance new projects with debt  Interest payments are legal obligations and creditors can force bankruptcy  Wealth transfer – transactions that create value to shareholders at the expense of creditors (eg/ leveraged buyouts, LBO)  Covenants – lender giving loan will take a covenant; ROI cannot fall below or rise above certain ratio o Equity  No legal obligation, no covenant, shareholders do not charge interest  Does not have the best ROI Liabilities  3 Characteristics of a Liability 1. A present obligation that entails settlement by probable future transfer or use of cash, goods or services 2. There is little or no discretion to avoid the obligation 3. Obligation arises from a transaction or event which has already occurred (i.e. past transaction)  Liabilities measured in terms of cash equivalent when first recorded; interest to be paid not initially included (interest accrues and becomes liability)  Current and Non-Current Liabilities Current Liabilities  Expected to be paid i) from existing current assets or through creation of new current liabilities ii) within the longer of one year or operating cycle  Short term debt expected to be refinanced (pay off debt with new debt)– may not be classified as current liability 1. Accounts Payable – amounts owed for goods, supplies or service purchased on open account; recorded when title has passed 2. Notes Payable – written promises to pay a sum of money on a specified future date; arises from purchases, financing or other transactions; ST or LT o Interest Bearing Notes – interest rate stated explicitly  Recording required when – i) note is issues ii) interest is paid iii) end of year (adjusting entry) o Non-Interest Bearing – interest notexplicitly stated, but note still earns interest; maker receives the face value of the loan minus interest and on due date pays face value 3. Current Portion/Maturities of Long Term Debt – portion of LT debt maturing within 12 months from balance sheet date o LT Debt should not be reported as current liabilities if they – i) are retired by assets not classified as current ii) are refinanced or retired by new issues of debt iii) are converted into share capital o Liability due on demand or within a year or operating cycle  current liability 4. Unearned Revenues – when cash is received before the product is delivered or service is rendered; crated by the transaction o When cash is received Cash xx Unearned Revenue xx o When revenue is earned Unearned Revenue xx Revenue xx 5. Sales Taxes Payable – kept on books between time business collects sales tax on behalf of CRA and when business remits check to CRA o Collecting Tax Cash xx CRA Payable xx o Remittance CRA Payable xx Cash xx 6. Goods and Services Tax Payable 7. Property Taxes Payable – paid to local government; accrued monthly; estimated until business receives property tax notice o Journal Entry 2 EXAM STUDY NOTES COMM 2AA3 Property Tax Expense xx Property Taxes Payable xx 8. Income Taxes Payable 9. Employee-Related Liabilities o Salaries or wages owed to employees at end of accounting period o Payroll deductions owed to CRA and others – until deductions are remitted to the government, they are reported as current liabilities  Statutory (mandatory) – include i) Canada Pension Plan (CPP) ii) Employment Insurance (EI) iii) Income Tax Withholding (f=Federal and Provincial)  Discretionary – include i) insurance premiums ii) union dues o Compensated absences obligations – absences from employment in which employees are paid (eg/ sick days)  Accrued if – i) employers liability related to services already rendered by employees ii) liability relates to employees vested or accumulated rights iii) payment of the compensation is probable iv) amount can be reasonably estimated  Recognized in the year the benefit is earned by employees o Bonuses 10. Estimated Liabilities (B/S) – litigation, claims and assessments; warranties and guarantees; premiums, coupons and air miles; environmental liabilities 11. Contingent Liabilities and Commitments – depends on future outcome; a liability incurred as a result of a loss contingency o Contingency – an existing condition or situation involving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur;accounting only recognizes loss contingency o Loss Contingencies (General) – involve situations of possible loss at the B/S date  Accrued if both of the following conditions are met (not necessary that the exact payee or exact date of payment is known: 1. It is likely that a future event will confirm that a liability has been incurred; at B/S date 2. The amount of loss can be reasonably estimated Probability/Likelihood of Occurrence Reasonably Estimated Not Reasonable Estimated Likely Accrue Notes Not Likely No Disclosure Not Determinable Notes – disclose the nature of contingency and an estimate of the amount or an explanation that an estimate cannot be made Long-Term Notes Payable  Normally repayable in a series of periodic payments, consisting of i) interest on unpaid balance of loan ii) reduction of loan principle  LT notes; payment can be for – i) interest
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