Chapter 8 Notes
Capital Assets – Tangible and Intangible
Capital asset: assets with lives longer than a year that are used in the company’s
operations to generate revenue.
- probable future value of an asset – capital assets are used to generate
revenues, usually by producing products, facilitating sales, or providing
services.
- Ultimate disposal value – use for some years then replace them/ sell them .
etc. --- residual value – the asset’s expected value at the end of its use.
How are capital assets valued?
Historical cost
- asset’s original cost is recorded at the time of acquisition. Changes in the
asset’s market value are ignored in this system.
- ***** during the period in which the asset is used, its cost is expensed
(depreciated) using an appropriate depreciation method.
- Market values are recognized only when the asset is sold.
- The company then recognizes a gain or loss on the sale, which is determined
by the differenced between the proceeds from the sale and the net book
value (original cost – the portion that has been charged to expense in
the form of depreciation)
Market Value
- replacement cost : the amount that would be needed to acquire an
equivalent asset
- net realizable value: assets are recorded at the amount that could be
received by converting them cash (ie selling them)
Canadian Practice
- most capital assets are valued at their depreciated historical cost
- an asset can never be valued at more than the amount that can be recovered
from it
o net recoverable amount: the total of all the future cash flows related
to the asset, without discounting them to present values.
o Impairment loss: if it is ever determined that an asset’s carrying
value exceeds its net recoverable amount.
Capitalizable costs notes
capitalized: at the date of the acquisition, the company must decide which costs
associated with the purchase of an asset should be included in the asset’s costs.
Capitalizable cost: any cost that is necessary to acquire the asset and get it ready
for use.
EGS:
- purchase price
- direct taxes - interest cost
- legal costs
- shipping or transportation costs
- prep, installation, set-up
- why do we capitalize costs? --- > matching principle - related costs are recor`
-any cost incurred that is not capitalized as part of the asset cost would be expensed
in the period of the purchase
Land improvements: things done to the land to improve its usefulness, but which
will not last forever . Installation of stuff.
debited to land, land improvements, buildings, equipment, or an expense account.
For each expensed item, explain why it was not appropriate to add the amount to an
asset.
Basket Purchase and Depreciation
Basket purchase: acquiring several assets in one transaction
-must divide the price paid between the assets’ fair values at the time of the
acquisition.
Pg520 in txtbk
Fair Value Percentage Purchase Price of Basket Allocated Cost
X $250 000 25% $880 000 $220 000
Y $750 000 75% $880 000 $220 000
------------ -
$1 000 000
*splitting the cost can have significant consequences wrt if the assets need to be
depreciated.
Interest Capitalization
- companies borrow large sums of money to finance the acquisition of a large
capital asset --- the interest paid is sometimes capitalized instead of
expensed.
Depreciation Concepts Depreciation: systematic and rational method of allocating the cost of capital assets
to the periods in which the benefits from the assets are received.
Straight-line method: - simple, most common, allocates the asset’s depreciable cost
evenly over its useful life, every year, etc.
-rate or depreciation, evenly deducted.
-relates to time
-majority of companies use this, b/c of its simplicity
Acq
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