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ADM1340 (150)
Chapter 9

ADM1340 Chapter 9: The Purpose and Use of Financial Statements - Lamia Chorou

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Lamia Chourou

Chapter 9 - Reporting and Analysing Long -Lived Assets Reporting and Analysing Long -Lived Assets • Property, Plant, and Equipment o Determining Cost o Depreciation o Derecognition • Intangible Assets and Goodwill o Accounting for intangible assets o Goodwill • Statement Presentation of Long -Lived Assets o Statement of financial position o Income statement o Statement of cash flows • Analysing assets o Return on assets o Asset turnover o Profit margin revisited Property, Plant, and Equipment • These are the resources that a company controls, are tangible, and are not for sale to the customers • These are used for production, and the sale of goods and services • This assets provides benefits for many years • Determining Cost o Determining the price consists of three steps • The purchase price, including tax • The expenditures to bring the asset to the required location • An estimate of any future obligations, to remove to fix the asset o Usually only costs that benefit are expensed • Operating expenditures § The cost of operating the asset • Capital expenditures § The cost that benefit future periods are capitalized in a long -lived asset account • Insurance should also be included since you can benefit from it • However, the training for the employees would not be added since the costs were to get the employees ready o At the end of the life of the asset, there might be some obligations to remove or restore it • This is asset retirement c osts o Subsequent to acquisition of a long -lived asset, the same distinction exists between operating and the capital expenditures • Operating expenses benefit only in the current period • Capital expenses would include costs that increase the life of an asset or its productivity or efficiency o Property, plant, and equipment are subdivided in 4 classes • Land § This includes all purchases related to land, including all legal fees § If some clearing is needed, it is also added to the Land Account § When recorded, Land is debited, and Cash is credited • Land improvements § This are the additions made to the land, it can be anything from driveways, to sidewalks, fences, or lighting § This will be added the Land Improvements § Since things may damage, and ne ed replacement, its recorded separately from land since it will be depreciated over the useful life • Buildings § This is all the purchases related to construction § The costs include the price of the building and other legal fees • This can include remodelling , or repairing anything § All of these are put in the Buildings account § When a building is built, you also have to pay for contracts, and architect fees • Also loans, if applicable § If the land and building are purchases together, the fair value of each must be determined and recorded separately • Equipment § This include the fees for the equipment, and the delivery § Some equipment can be vehicles that the company will use • It can fall into two accounts • Equipment or Vehicles § You debit the vehicle expense, and c redit cash o To buy or lease? • In this agreement, the owner of the assets agrees to let someone rent the asset § The lessor is the party allowing the asset to be leased, the lessee if the party paying to rent the asset • Leasing is a common practice in the business world • There are some advantages of leasing rather than purchasing an asset § Reduced risk of obsolesce • Obsolesce is the process of an asset becoming out of date, with leasing you can always ask for a more modern asset § 100% financing • Leasing does not require a down payment, which helps conserve cash § Income tax advantage • If the company has borrowed to purchase an asset, it can also deduct the interest expense on the borrowed funds. When a company leases an asset, it simply deducts t he rent paid on its income tax return. In some years, this deduction may be greater than the deductions taken if the asset was owned. § Off-balance sheet financing • If you rent it, you don’t have a liability, bank loan, and it won't show on your financial statement • Under IFRS, lease transactions must be accounted for § If the risks and rewards of ownership are transferred to the lessee, then the lased asset must be treated like a purchased financed with a loan provided by the seller of the asset • If the risks and rewards are not transferred, this is called an operating lease • No asset or liability is recorded • It is recorded as rent • Depreciation o Companies have two models to choose when accounting of PPE • The cost model § This is more commonly used under IFRS § This records PPE when acquired § Depreciation is recorded each period § Depreciation is the systematic allocation of the cost of PPE over the asset's useful life • Depreciation expense is debited, and accumulated depreciation is credited • Depreciation is a process of cost allocation, not a process of determining an asset's fair value • Depreciation neither uses up nor provides cash to replace the asset • The revaluation model § This is used on a limited basis • This is mainly used by companies c ertain industries, like investments, real estate § The carrying amount of PPE is adjusted to reflect its fair value • This can only be applied to assets whose fair value can be reliably measured § Revaluation gains or write -ups are also recorded o Depreciation only applies to land improvement, buildings, and equipment o Factors in calculating depreciation • Cost § The price paid for the asset • Useful life § How long will this asset be available to use • Residual value § The amount the asset is worth at the end of its usefu l life o Depreciation methods • There are three methods § Straight-line • This is the most common depreciation method • This calculates depreciation in two steps • Cost - Residual Value = Depreciable Amount • Depreciable Amount/Useful Life = Depreciation Expense • You can also divide 100% by the useful life, to see how % it will go down per year • The depreciation method must be consistent with the pattern in which the economic benefits from owning the assets § Diminishing-balance • This produces an annual decreasing de preciation over the useful life • The depreciation rate remains constant from year to year, but the carrying amount that the rate is applied to declines each year • The residual value is not used in determining the amount that the diminishing -balance rate is applied to • To calculate this you need to use the straight -line rate • Depreciation rate = Straight -line rate x multiplier • Carrying Amount at Beginning of Year x Depreciation rate = depreciation expense § Units-of-production • The useful life is expressed usin g a measure of output, like units produced, rather than number of years • This works well for vehicles, where depreciation is measured in kilometres driven • This is not something to use on buildings or furniture • To use this, you need to fund the total unit production for the entire useful life • Which is estimated • Cost - Residual Value = Depreciable Amount • Depreciable Amount/Estimated Total Units of Activity = Depreciable Amount per Unit • Depreciable Amount per Unit x Unit of Activity During the Year = Deprec iation Expense • With this method, the depreciation can be different every year • An asset can become more or less valuable o Other depreciation issues • There are other issues that can occur related to depreciation • Significant components § This is when individual parts of the asset have different useful lives • The cost of the item should be allocated § This allows all components to be depreciated separately over different useful life § A component with a shorter useful life can be changed, with out having to toss out the whole machine • Depreciation and income tax § Depreciation amount should be determined by using tax regulations • This is used so when preparing for tax return, the companies cannot deduct the depreciation expense • They must deduct the income tax of depreciation • Impairments § Sometimes the PPE is undervalued on the statement, carrying a lower than fair value • Its not fair to overvalued the asset § Companies have to determine indicators of impairment on a regular basis § The recoverable amount can be determined by observing the fair value less selling costs of similar assets in an active market § Impairment loss is when a long-lived asset it impaired, and its recorded to equal the amount by which the
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