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Chapter 7

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Department
Management
Course
MGT120H5
Professor
Catherine Seguin
Semester
Winter

Description
Chapter 7 - PPE & INTANGIBLE ASSETS Types of assets • Tangible long lived assets are called property, plant, and equipment. Buildings, airplanes, equipment. And the expense that is associated with these assets is called depreciation. LAND however is not expensed over time because its usefulness doesn't decrease. • Intangible assets are useful because of the special rights they carry. Have no physical form. Patents, copyrights, trademarks and goodwill. • Summary: LAND does not get depreciated but PPE does. Intangible assets are amortized* except for goodwill. Measuring the cost of PPE • The cost of land includes its purchase price (cash plus any note payable given). Note payables like real estate commission, survey fees, legal fees, and any back property taxes that the purchaser pays. • Land cost also includes expenditures for grading and clearing the land and demolishing or removing unwanted buildings. • The cost of land doesn't include the cost of fencing, paving, sprinkler systems, and lighting. These are recorded in a separate account -- called LAND IMPROVEMENTS -- and these are subject to depreciation. • EXAMPLE: pretend canadian tire signs a $300,000 note payable to purchase 20acres of land for a new retail store. Canadian tire also pays $10,000 for real estate commission, $8000 of back property tax, $5000 for removal of an old building, a $1000 survey fee, and $260,000 to pave the parking lot -- all in cash. What is the cost of Canadian Tire's cost of this land? Purchase price of land $300,000 Add related costs: Real estate commission $10,000 Back property tax 8,000 Removal of building 5,000 Survey fee 1,000 Total related costs 24,000 Total cost of land $324,000  **cost to pave the parking lot, $260,000, isn't included in the land's cost, because the pavement is a land improvement. Canadian Tire would record that transaction as: Land $324,000 Note payable $300,000 Cash $24,000 • THE PURCHASE INCREASES ASSETS AND LIABILITIES, EQUITY IS NOT AFFECTED. Buildings, machinery and equipment • The cost of constructing a building includes architectural fees, building permits, contractor's chargers, payments for materials, labour, and overhead. The company may also include the interest on money borrowed to construct the building or buy machinery and equipment. • When an existing building (new or old) is purchased, its cost includes the purchase 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 prices (less any discounts), plus transportation, insurance while in transit, sales and other taxes, purchase commission, installation costs, and any expenditures to test the asset before it is placed in service. The equipment cost 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, not as part of the asset's cost. Land improvements and leasehold improvements • This account, like form the canadian tire example, includes pavements (driveways), signs, fences, and sprinkler systems. This account is subject to decay, depreciation. • If the company leases (borrows) an item and provides improvements on that item. This cost will appear under PPE account or Other Long-Term Assets. The cost of leasehold assets are to be depreciated over the term of the lease or the life of the asset, whichever is shorter. ON PAGE 340. Lump-sum (or basket) purchases of assets • Purchasing several assets as a group or in a "basket", with a single price. • The company must find the cost of each asset, the total cost is divided among the assets according to their relative fair values. • EXAMPLE: let's say you bought land a building for the cost of $2,800,000. An appraisal indicates that the land's fair value is $300,00 and that the building's market value is $2,700,000 (those two numbers represent the FAIR VALUE). o The company would first have to calculate the ratio of each asset's fair value to the total fair value. o So...the total appraised value is (2,700,000+300,000) $3,000,000 (TOTAL FAIR VALUE). o FAIR VALUE/TOTAL FAIR VALUE= % OF FAIR VALUE * TOTAL COST = COST OF EACH ASSET. o Land: $300,000/3,000,000 = %10 * 2,800,000 = $280,000 o Building: 2,700,000/3,000,000 = 90% * 2,800,000 = $2,520,000 Capital expenditures vs. An immediate expense • Expenditures that increase the asset's productivity or extend its useful life are called capital expenditures. Like, the cost of a major overhaul that extends the useful life of a Canadian Tire truck is a capital expenditure. Capital expenditures are capitalized, which means the cost is added to an asset account and not expensed immediately. • A major decision in accounting PPE is whether to capitalize or expense a certain cost. • Costs that don't 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. Like, Repair Expense is reported on the income statement. • Distinction between capital expenditure and expense requires judgement. • If you expense a cost that should have been capitalized. This error overstates expenses and understates net income in the year of the error • If you capitalize a cost that should have been expense. This error understates expenses and overstates net income in the year of the error Measuring PPE and depreciation • Cost - accumulated depreciation = carrying amount of PPE (this is recorded on the balance sheet) • Accumulated is recorded on balance sheet, depreciation expense is recorded on the income statement. • Only land has an unlimited life. • Depreciation is caused by physical wear and tear (physical deterioration), 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. And asset's useful life may be shorter than its physical life. • Depreciation isn't a process of valuation. Businesses don't record depreciation based on changes in the fair value of their PPE. Instead businesses allocate the asset's cost to the periods of its useful life based on a specific depreciation method. • Depreciation doesn't mean setting aside cash to replace assets as they wear out. Any cash fund is entirely separate from depreciation How to measure depreciation • YOU NEED THE COST, ESTIMATED USEFUL LIFE, AND ESTIMATED RESIDUAL VALUE. • Estimated useful life is the length of service expected from using the asset. • Estimated residual value - also called salvage value - is the expected cash value of an asset at the end of its useful life. If there's no residual value, the full cost of the asset is depreciated. An asset's depreciable cost is measured as: DEPRECIABLE COST = ASSET'S COST - ESTIMATED RESIDUAL VALUE. • DEPRECIATION METHODS: straight line, units of production, diminishing balance STRAIGHT LINE METHOD: • (cost-residual value)/ useful life in years = straight line depreciation PER YEAR. • The entry to record depreciation is: DR, depreciation expense. CR, accumulated depreciation. • Depreciation decreases the asset and equity (through expenses). • LOOK ON PAGE 346 UNITS OF PRODUCTION METHOD: • This has a fixed amount of depreciation that is assigned to each unit of output, or service produced by the asset. • (cost - residual value)/ useful life, in units of production = units of production per unit of output. DIMINISHING-BALANCE METHOD: • An accelerated depreciation method writes off a larger amount of the asset's cost near the start of its useful life than the straight-line method does. • Double-diminishing-balance is the main accelerated depreciation method. (DDB) o First, compute the straight line depreciation rate per year and multiply the answer by 2. (1/useful life in years)*2. o Second, multiply the DDB rate by the period's beginning asset carrying amount (cost-accumulated depreciation). IN THIS METHOD, you ignore the residual value when computing depreciation. o Third, determine the final year's depreciation amount, which is the amount needed to reduce the asset carrying amount to its residual value - not its cost. o ^ the residual value shouldn't be depreciated but should remain on the books until the asset is disposed of. o ON PAGE 348 • DDB * asset carrying amount = depreciation expense.
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