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Chapter 7

COMMERCE 1AA3 Chapter Notes - Chapter 7: Ddb Worldwide, Book Value, Income Statement


Department
Commerce
Course Code
COMMERCE 1AA3
Professor
Emad Mohammad
Chapter
7

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Chapter 7 - Property, Plant, and Equipment and Intangible
Assets
Learning Objective One: Describe the Types of Tangible and Intangible
Assets a Business May Own
Businesses use several types of assets that are classified as long-lived
o These assets are used in the business and are not held for same
Tangible long-lived assets are also called property, plant, and equipment
o The cost of these assets must be expensed over their useful lives and the expenses
associated with this is depreciation
o Land is the only long-lived asset that is not depreciated because its usefulness does
not decrease
o Many companies report tangible long-lived assets as property, plant, and equipment
on the balance sheet
To find out what is included in this section, you need to read the notes that
accompany the financial statements
Intangible assets are useful because of the special rights they carry
o Have no physical form
o Include copyrights, trademarks, and goodwill
o Accounting for intangibles (except goodwill) is similar to accounting for tangible
long-term assets
Not all companies have both tangible and intangible assets
Learning Objective Two: Measure and Account for the Cost of
Property, Plant, and Equipment
The cost of any asset is the sum of all the costs incurred to bring the asset to its location
and intended use
The cost of property, plant, and equipment includes its purchase price, any taxes,
commissions, and other amounts paid to make the asset ready for use
Land
The cost of land includes it purchase price, real estate commission, survey fees, legal fees,
and any back property taxes that the purchaser pays
Also includes expenditures for grading and clearing the land and demolishing or removing
unwanted buildings
Does not include the cost of fencing, paving, sprinkler systems, and lighting
o Recorded in a separate account called land improvements and are subject to
depreciation
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Buildings, Machinery, and Equipment
The cost of constructing a building includes architectural fees, building permits,
contractors' charges, and payments for material, labour, and overhead
May also include as cost the interest on money borrowed to construct a building or buy
machinery and equipment for the building until the point in time when the building,
machinery, and equipment are ready for their intended use
When an existing building is purchased, its cost includes the purchase price, brokerage
commission, sales and other taxes paid, and all expenditures to repair and renovate the
building for its intended purpose
The cost of machinery and equipment includes its purchase price plus transportation,
insurance while in transit, non-refundable sales and other taxes, purchase commission,
installation costs, and any expenditures to test the asset before it is placed in service
o The cost of equipment will also include the cost of any special platforms used to
support the equipment
After the asset is up and running, insurance, taxes and maintenance costs are recorded as
expenses
Land Improvements and Leasehold Improvements
The land improvements account includes costs for items such as driveways, signs, fences,
and sprinkler systems
o They are subject to decay and their cost should therefore be depreciated
The cost of improvements to leased assets may appear under Property, Plant, and
Equipment or Other Long-Term Assets
o The cost of leasehold improvements should be depreciated over the term of the
lease or the life of the asset, whichever is shorter
Lump-Sum (or Basket) Purchases of Assets
Businesses often purchase several assets as a group for a single lump-sum amount
The company must identify the cost of each asset
o The total cost is divided among the assets according to their relative fair values
Capital Expenditure Versus and Immediate Expense
When a company spend money on property, plant, and equipment, it must decide
whether to record an asset or an expense
Expenditures that increase the asset's productivity or extend its useful life are called
capital expenditures
o Said to be capitalized, which means the cost is added to an asset account and not
expensed immediately
A major decision in accounting for property, plant, and equipment is whether to capitalize
or expense an account
Costs that do not extend the asset's productivity or its useful life, but merely maintain the
asset or restore it to working order, are considered repairs and are recorded as expenses
The distinction between a capital expenditure and an expense requires judgement: does
the expenditure extend the asset's productivity or its useful life?
o Capitalize it
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o If the cost merely repairs or maintains the asset or returns it to its prior condition,
then record an expense
Most companies expense all small costs
o For higher costs, they follow the above rule
A conservative policy is one that avoids overstating assets and profits
o A company that overstates its assets may get into trouble and have to defend itself
in court
o Whenever investors lose money because a company overstated its profits or its
assets, the investors might follow a lawsuits
Accounting misstatements sometimes occur for assets; a company may:
o Expense a cost that should have been capitalized, this error overstates expenses and
understates net income in the year of the error
o Capitalize a cost that should have been expensed, this error understates expenses
and overstates net income in the year of the error
Learning Objective 3: Calculate and Record Depreciation on Property,
Plant, and Equipment
Property, plant, and equipment are reported on the balance sheet at their carrying
amount
o Carrying amount of property, plant, and equipment = cost - accumulated
depreciation
Property, plant, and equipment wears out, grows obsolete, and loses value over time
o To account for this process, we allocate an asset's cost to expense over its life - a
process called depreciation
The depreciation process begins when an asset is available for use and continues until the
asset is removed
o In the private sector, it is referred to as amortization
o The depreciation expense is reported on the income statement
Only land has unlimited life and is not depreciated for accounting purposes
Most property, plant, and equipment have limited lives because of:
o Physical wear and tear: for example, physical deterioration takes its toll on the
usefulness of WestJet's airplanes, vehicles, and buildings
o Obsolescence: computers and other electronic equipment may be obsolete before
they deteriorate
An asset is obsolete when another asset can do the job more efficiently
An asset's useful life may be shorter than its physical life
Depreciation is not a process of valuation
o Businesses do not record depreciation based on changes in fair value of their
property, plant, and equipment
Businesses allocate the asset's cost to the periods of its useful life based on a
specific depreciation method
Depreciation does not mean setting aside cash to replace assets as they wear out
o Any cash fund is entirely separate from depreciation
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