Chapter 8 Capital Assets Tangible and Intangible
- Capital assets: assets with lives longer than a year (or operating cycle) that are
used in the companys operations to generate revenue.
- Tangible assets: which are usually defined as those assets with some physical
- Intangible assets are non-current assets that are associated with certain legal
rights or privileges the company has, such as patents, trademarks, leases and
CAPITAL ASSET RECOGNITION
- When a company buys a capital asset: it has to the right to use the asset and a
transaction as occurred.
- Must have future value, either it generate revenues, usually by producing
products, facilitating sales, or providing services. The future value is represented
by the cash that will eventually be received from the sales of products and
services. Sometimes referred to as value in use.
- Second source of value for capital assets is their ultimate disposal value which is
called residual value (or resale value).
- Difficulty with value in use concept is that the future revenue that will be
generated by using the asset is inherently uncertain.
HOW ARE CAPITAL ASSETS VALUED?
- In Canada, property, plant, and equipment are usually values at historical cost,
with no recognition of any other value unless the assets value becomes
impaired (i.e., the value of the estimated future cash flows is less than the
current carrying value).
- IFRS allows the recognition of changes in the market values of property, plant and
- The assets original cost is recorded at the time of acquisition.
- Depreciation method
- Market values are recognized only when the asset is sold. Recognize gain or loss
on the sale which is determined by the difference between the proceeds from
the sale and the net book value (or carrying value).
- This net book value or carrying value is the original cost less the portion 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. If the assets replacement cost goes up, the depreciation expense will also
have to go up, to reflect the higher replacement cost. A realized gain or loss is
recognized upon disposal of the asset.
- Net realizable value: assets are recorded at the amount that could be received by
converting them to cash; in other words, selling them. Depreciation in this type
of system is based on the net realizable value and is adjusted each time the asset
What is Canadian Practice?
- Most capital assets are valued at their depreciated historical cost. During the
periods of use, the assets cost is expensed using a depreciation method that is
rational, systematic and appropriate to the asset.
- With the adoption of IFRS, some companies may decide to change to the market
values for their capital assets.
- Under both historical cost and net realizable value, an asset cannot be valued at
more than the amount that can be recovered from it. The net recoverable
amount is the total of all the future cash flows related to the asset, without
discounting them to present values. If it carrying value exceeds net recoverable
amount, then it must be written down and the difference recognized as an
- Accounting standards for private sector enterprises allow only the historical cost
method for valuing capital assets.
- At the date of acquisition, the company must decide which costs associated with
the purchase of the asset should be included as part of the assets cost, or
- Any cost that is necessary to acquire the asset and get it ready for use is a
- Any cost incurred that is not capitalized as part of the asset cost would be
expensed in the period of purchase.
- Why capitalize ancillary costs? Because of matching principle. If these related
costs are reported as part of the assets cost, they will be charged to expense in
future periods, as depreciation, in order to match them to revenues that are
generated while the asset is being used.
- Land will also be there for company to use, thats why it doesnt depreciate. Costs will be in statement of financial positions, and will not appear on the statements
of earnings in the future, as depreciation expense.
- Land improvements refers to things done to the land to improve its usefulness,
but which will not last forever.
- Influenced by income tax regulations, companies would like to expense as many
costs as possible, in order to reduce their taxable income and save on taxes.
- Capitalizing costs means that companies have to wait until the assets are
depreciated before the costs can be deducted for tax purposes.
- Materiality criterion also plays a part in which costs are capitalized.
- Basket Purchases
Basket purchases: company acquires several assets in one transaction.
Need to be split as different assets because full disclosure requires that
each important type of asset be reported separately on the statement of
financial position, assets have different rates of depreciations, and even
some doesnt have depreciation like land.
- Companies often borrow money to finance the acquisition of a large capital
asset. Interest paid on the borrowed money is sometimes capitalized, by
including it in the capital asset account rather than recording it as an expense.
- Can capitalize interest costs for capital assets that are constructed or acquired
over time, if the costs are directly attributable to the acquisition. Then it must be
expensed once the asset is ready to be used.
- For assets that are purchased rather than constructed, interest costs are usually
- Depreciation is a systematic and rational method of allocating the cost of capital
assets to the periods in which the benefits from the assets are received.
- The company does not show the capital assets entire cost as an expense in the
period of acquisition, because the asset is expected to help generate revenues
over multiple future periods.
- To allocate the expense systematically to the appropriate number of periods, the
company must estimate the assets useful life (the periods over which the
company will use the asset to generate revenues). Must also estimate the
residual value that will be at the end of its useful life.
- Once the assets useful life and residual value have been estimated, its
depreciable cost (acquisition cost minus the residual value) is the portion that must be depreciated and will be allocated in a systematic and rational way to the
years of useful life.
- Straight-line method, which allocates the assets depreciable cost evenly over its
useful life. Accountants use it because its simple to apply and for assets that
generate revenue evenly throughout their lives, it properly matches expenses to
revenues. As well the asset deteriorates evenly throughout its life.
- Units-of-activity or production method, it recognizes that the usefulness or
benefits derived from some capital assets can be measured fairly specifically.
- Accelerated or declining-balance method, the decline in their revenue-generating
capabilities (and physical deterioration) does not occur evenly over time.
- Decelerated or compound interest method, argues that for some assets the
greatest change in usefulness and/or physical deterioration takes place during
the last years of the assets life, rather than the first years.
Recording Depreciation Expense
- The account Depreciation Expense is debited and Accumulated Depreciation is
- Accumulated depreciation account is a contra asset account that is used to
accumulate the total amount of depreciation expense that has been recorded for
the capital asset over its lifetime.
CORPORATE INCOME TAXES
- The CRA does not allow companies to deduct depreciation expense when
calculating their taxable income.
- However, it does allow a similar type of deduction, called capital cost allowance
- The net carrying value of the capital assets in the companys accounting records
will be different from the value in its tax records.
- For tax purposes, the net carrying value of capital assets is referred to as their
undepreciated capital cost (UCC).
- Deferred income tax asset: the difference of the NBV and UCC.
CHANGES IN DEPRECIATION ESTIMATES AND METHODS
- Sometimes asset changes its useful life, may be longer or shorter. It does not
change past periods though.
- Page 532 for example