Textbook Notes (368,794)
Canada (162,165)
BUS 251 (101)
Chapter 8

BUS 251 - Financial Accounting: A User Perspective SIXTH Canadian edition - Chapters 8, 10, 11

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Business Administration
BUS 251
Steve Gibson

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 form. - Intangible assets are non-current assets that are associated with certain legal rights or privileges the company has, such as patents, trademarks, leases and goodwill. 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 equipment. Historical Cost - 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 is revalued. 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 impairment loss. - Accounting standards for private sector enterprises allow only the historical cost method for valuing capital assets. Capitalizable Costs - 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 capitalized. - Any cost that is necessary to acquire the asset and get it ready for use is a capitalizable cost. - 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. Interest Capitalization - 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 not capitalized. DEPRECIATION CONCEPTS - 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. DEPRECIATION METHODS - 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 credited. - 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 (CCA). - 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
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