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Final Review.docx

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McMaster University
Teal Mc Ateer

Final Review 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 Tangible assets: Resources that have physical substance (a definite size and shape), are used in the operations of a business, and are not intended for sale to customers. Also called property, plant, and equipment; fixed assets; capital assets; and operational assets Except for land, all tangible assets are subject to depreciation or depletion (natural resources. Measured at acquisition costs Intangible assets: assets involve rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Include patents, copyrights, trademarks, franchises, and goodwill Some intangibles are subject to amortization Acquisition Costs (building) Purchase price, architectural fees, renovation and repair costs and cost of permits, legal and realty fees, title fees and excavation and construction cost (Equipment) Purchase price, installation costs, modification to building necessary to install equipment and transportation costs (Land) Purchase price, real estate commissions, title insurance premiums, delinquent taxes, surveying fees, title search and transfer fees …. Land is not amortizable Acquisition for noncash consideration: Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. Other long lived assets include: constructed assets, leased assets and asset retirement obligations Acquisition as a basket purchase Example XYZ Inc. paid $2,000,000 in a basket purchase of land, a building, and equipment. An appraisal indicated the following market values at the time of the purchase: Land $ 800,000 Building 1,250,000 Equipment 250,000 Prepare the journal entry to record transaction. Solution Total appraised value = 800,000 + 1,250,000 +250,000 = $2,300,000 Cost of the land = 2,000,000 x (800,000 / 2,300,000) = $695,652 Cost of the building = 2,000,000 x (1,250,000 / 2,300,000) = $1,086,957 Cost the equipment = 2,000,000 x (250,000 / 2,300,000) = $217,391 Land 695,652 Building 1,086,957 Equipment 217,391 Cash 2,000,000 Subsequent Costs Two types of expenditures: Capital:increase the productive life, operating efficiency, or capacity of the asset and are recorded as increases in asset accounts not as expenses Revenue: maintain the productive capacity of the asset during the current accounting period only and are recorded as expense Repairs, maintenance and betterments Betterments: costs incurred to enhance the productive or service potential of a lla Type of Capital or Expenditure Revenue Identifying Characteristics Ordinary 1. Maintains normal operating condition repairs and Revenue 2. Does not increase productivity maintenance 3. Does not extend life beyond original estimate Extraordinary Capital 1. Major overhauls or partial repairs replacements 2. Extends life beyond original estimate Betterments Capital 1. Increases productivity 2. May extend useful life 3. Improvements or expansions Capital and Revenue Expenditures Many companies have policies expensing all expenditures below a certain amount according to the materiality constraint. Capital Cost allowance: when and how much you can depreciate Financial Statement Effect Current Current Treatment Statement Expense Income Taxes Capital Balance sheet Expenditure account debited Deferred Higher Higher Revenue Income statement Currently Expenditure account debited recognized Lower Lower Depreciation Allocating to expense the cost of an asset over its useful life in a rational and systematic manner, in accordance with the matching principle Process of cost allocation, not asset valuation, valuation is selling the item Not a cash fund Methods of depreciation: straight-line (used in accounting, IFRS), declining-balance (used in CRA, for tax purposes), sum-of-years-digit and units-of-activity Factors in Calculating depreciation Cost: the original/historical price Useful life: estimate of how long it will last Salvage Value: estimate of what you will get at the end of the useful life Depreciable cost= Cost- salvage value Straight-Line =Depreciable cost/useful life Declining Balance Method accelerated depreciation method (more in early years and less in later years) =beginning book value times depreciation rate 2/useful life= double-declining balance rate (depreciation rate) Sum of year’s digits (SYD) also accelerated =depreciation cost * (n/SYD) N is useful life in the year, SYD= [n* (n+1)]/2, n decreases each year (new rate each year) Units of Activity Useful life is expressed in terms of the estimated total units of production or use expected from the asset Depends on activity, no formula Income statement comparison: accelerated methods result in lower earnings in the early years and higher earnings in the later years Changes in estimated When a change in an estimate is required, the change is made in current and future years but not to prior periods Revised depreciation is calculated using the net book value at the time of the change in estimate. Asset impairment Impairment is the loss of a significant portion of the utility of an asset through casualty, obsolescence and lack of demand for the assets services Permanent impairment should be recognized as a loss Impairment loss=net book value – fair value Fair value is the value market is willing to give, if it is higher than market cost Account name is impairment cost Disposal or PPE sale of an asset Four steps to record: 1. update the depreciation 2. Calculate the NBV 3.Calculate the gain or loss 4. Record the disposal Natural Resources Extracted from the natural environment A noncurrent asset presented at cost less accumulated depletion, eg. Oil, coal and gold Total cost of asset is the cost of acquisition, exploration and development Total cost is allocated over periods benefited by the means of depletion Depletion is like depreciation Chapter 10: Recording and interpreting current liabilities Financing business Two ways: debt (liability) and equity (financing by owners, capital) Mix of debt and equity is called capital structure Debt financing is cheaper but riskier than equity because interest payments are legal obligations and creditors can force bankruptcy, when banks loan you money they have the power to take your company if you do not pay your interest Have to have a good ratio or the bank can take back the loan Debt Financing has advantage of financial leverage Wealth transfer: transactions that create value to shareholders at the expense of creditors -Companies choose to borrow money rather than sell shares for money because selling shares increases the loss of control in a company -financial leverage: increase benefit to shareholders by borrowing money - Capital gain: buy stock and sell it back for more The lower the roe the better, ROE= return on equity = new profit/SE Characteristics of a Liability Three essential: 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 transactions) Current liabilities Expected to be paid: From existing current assets or through the creation of other current liabilities Within one year or operating cycle, whichever is longer (construction example, 3years to build) Debts that do not meet both criteria are classified as long-term liabilities Therefore, short-term debt expected to be refinanced (going from lender to lender to pay off one debt) MIGHT NOT BE CLASSIFIED AS A CURRENT LIABILITY, IFRS states the intention for it to be current is okay Types of current liabilities: a. Accounts Payable- Trade A/P Amount owed for goods, supplies or services purchased on open account b. Notes Payable- Due within one year -Notes payable are written promises (piece of paper) to pay a sum of money on a specified future date -Arises from purchases, financing or other transactions -Notes payable may be classified as either short-term or long-term -Notes payable may be interest-bearing or zero-interest- bearing (non-interest-bearing) -In both cases, interest expense is determined whenever financial statements are prepared Difference between a/p and n/p -Specific date due -Always interest on a note -Can be long term 1. Interest Bearing notes: the interest rate is stated on note a. For long term can be paid for: interest only. Fixed principal plus interest or equal payments consisting of interest and principal 2. Non-interest bearing notes: although interest rate is not stated explicitly on the note the note still earns interest 3. Long term notes payable: Accounting issues for these interest-bearing notes are similar to those of short-term notes -Most long-term notes are normally repayable in a series of periodic payments c. Current Portion of Long-Term Debt: the portion of long- term debt maturing within 12 months from the balance sheet date is reported as a current liability i. Not current if: retired by not current assets, refinanced or retired by new issues of debt and they are converted into share capital d. Unearned Revenues: when cash is received before the product is delivered or service is rendered i. Effect on acc. Equation: A up, L up and down, SE up e. Sales Taxes Payable: Businesses collect sales taxes on behalf of the CRA, and then remit the check to the CRA f. Goods and Services Tax Payable g. Property Taxes Payable: paid to local governments, monthly for business and annually for individuals h. Income Taxes Payable i. Employee-related Liabilities: eg. Salaries or ages owed to employees at the end of the accounting period, norm is bi- weekly i. Payroll deductions: statutory (CPP, EI and income tax) and discretionary (insurance premiums and union dues) deductions ii. Compensated absences: absences from employment for which employees are paid, recognized in the year the benefit is earned by employees (earn diff from used) j. Estimated Liabilities Reported on the Balance Sheet: Litigation, claims, and assessments, warranties and guaranties, premiums, coupon and air miles and environmental liabilities k. Contingent Liabilities and Commitments: depend on future occurrences, such as warranties and airmiles i. Will not necessarily be used, but still exists Warranty either used or resolved, life time warranty is pro rated Law suit either win or lose, only loss is recorded in accounting however ii. Loss Contingences (general): involve situations of the possible loss at the balance sheet date
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