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Chapter 7

COMMERCE 1AA3 Chapter Notes - Chapter 7: Accelerated Depreciation, Ddb Worldwide, Capital Asset

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Emad Mohammad

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Long lived assets- used in the business but not held for sale
Tangible long lived assets- have physical form such as buildings and equipment
Intangible Assets- carry special rights but do not have physical form such as patents,
copyrights and trademarks
1. The usefulness of tangible assets is derived from their physical form
2. The cost principle directs a business to carry an asset on the balance sheet at
its original cost
When tangible long-lived assets are used the expense is referred to as Depreciation expense,
when intangible long-lived assets with exception of Goodwill are used the expense is referred
to as Amortization
Goodwill is subject to impairment losses rather than amortization or depreciation expense
1) Land- costs for the various categories of property, plant and equipment are as follows:
taxes, costs for grading and clearing the land and demolishing/removing unwanted
2) Building, Machinery, and Equipment- costs include:
a) Constructed buildings--- architectural fees, building permits, contato’s hages,
material, labour, overhead and interest occurred during construction
b) Existing buildings--- purchase price, brokerage commission, installation costs, costs
of a trial run, and special equipment platforms
3) Land improvements and leasehold improvements
a. Land improvements- improvements to land that will eventually deteriorate and
costs include fencing, paving, sprinkler systems, lighting, parking lots, and
b. Leasehold improvements- improvements to leased assets. Cost should be
depreciated over the term of the lease or life of the asset, whichever is shorter
4) Basket Purchase of Assets- purchase of several assets for a single lump-sum amount
a. Lump-sum cost must be allocated to the individual assets according to their
relative fair values
b. A atio of a idiidual asset’s aket alue to the aket alue of all of the
assets is ultiplied  the lup su puhase pie. The esult is the asset’s ost
Expenditures relating to long lived assets can be classified as:
Capital Expenditure: an epeditue that ieases the asset’s podutiit o to eted
its useful life
Immediate Expenditure: Costs that merely maintain the asset or restore it to working
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Expenditure will be realized in future, will not be used up in this period--- debit an asset
Epeditue’s eefit is ealized i uet peiod---- debit expense
Expenditure provides no additional benefit--- debit a loss
Depreciation- the process of allocating a long-lied asset’s ost to epese oe the asset’s
useful life due to physical wear and tear and/or obsolescence
- Not a process of valuation and does not mean setting aside cash to replace assets as
they wear out
To calculate depreciation:
1) Cost
2) Estimated useful life--- estimate of years the asset will be useful, not an estimate of its
physical life
3) Residual value (salvage value) --- estiated ash alue at the ed of the asset’s useful
a. Depreciable cost (amount that is depreciated)- asset’s ost – estimated residual
Straight-Line Method: (Cost Residual Value)/Useful Life, in years
a. Alloates eual aout of epese to eah ea of the asset’s life
b. Accumulated Depreciation- a contra-asset aout… potio of the asset’s ost that
has already been amortized (or expensed)
c. Depreciation Expense XXX
a. Accumulated Depreciation XXX
d. Best fits assets that generate revenue evenly overtime
Carrying Value/Book Value = cost accumulated depreciation
Unit of Production (UOP): (Cost Residual Value)/Useful life in units of production
a. Assigns a fixed amount of depreciation to each unit of output or production
b. Depreciation each period will vary based on the units of output
c. Best fits assets that wear out due to physical use rather than obsolescence
Double Balance (DB) is an accelerated depreciation method
a. Accelerated depeiatio ethods aotize highe aouts of the asset’s ost i the
eal eas of the asset’s life, ad loe aouts of the asset’s cost are amortized in the
late eas of the asset’s life
b. DDB rate = 2/useful life
Depreciation Expense = Carrying Value x DDB rate
c. best first assets that generate greater revenue earlier in their useful lives
Companies will calculate depreciation if asset is purchased on or before the 15th of a month
Depreciation must be revised if there is a change in useful life or residual value
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