MGAB02H3 Chapter 9: Topic 1: Chapter 9

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University of Toronto Scarborough
Financial Accounting
Liang Chen

CH. 9: PPE Long-lived Assets: ​resources owned by business/used in operations to produce benefits over several years… I. Tangible:​ PPE A. Land; ​does not become obsolete so NEVER depreciated but may impair in value B. Buildings, fixtures, equipment; ​ex) property, equipment, assets under finance lease C. Biological; ​living things, ex) pigs, trees, bushes D. Natural resources; ​mineral deposits such as gold/diamonds, oil wells, reserves II. Intangible: ​intellectual property A. Copyrights, patents, licenses, trademarks, software, franchises, subscription lists Fixed Asset Turnover Ratio: Net Sales (or operating revenues) / AVG Net Fixed Assets* ➔ *​[BEG + END Balances of PPE (net of acc. dep) / 2] ➔ How well is mgmt utilizing PPE to generate revenues? The ​higher​ the ​better ➔ **lower/declining ratio may = company is expanding (by acquiring more productive assets) **increasing ratio may = firm cut back on capital expenditures bc anticipates downturn in business, SO… this ratio requires investigation of related activities Measuring & Recording ACQUISITION Cost Cost Principle: ​all reasonable/necessary costs incurred in acquiring long-lived asset should be recorded. We say these costs are ​capitalized ​when they are ​recorded​ as ​assets​ ​instead​ of expenses. ➔ ADDED to A.V: ​sales taxes, legal fees, transportation costs, installation costs - added to purchase price​ of asset ➔ NOT Added to A.V: ​special discounts, interest charges - *included in ​cost​ of asset, ex) interest charges reported as interest expense Acquisition Methods: 1. Cash: ​DR Asset / CR Cash 2. Debt: ​DR Asset / CR AP 3. Equity (or other non-cash consideration): ​such as company’s shares of a right given to seller at cash-equivalent cost - DR Asset / CR SE 4. Construction: ​creating an asset includes all direct/indirect costs incl. Interest on any loans. When asset is ready, acc. costs will be depreciated over its life. Capitalized Interest: ​interest included in the cost of the construction which reduces the company’s total interest expense every year until the the asset is ready for use. Once construction completed, interest costs on loans, must be EXPENSED. EX) ​Bulk Barn completes construction of new head office called Campus. Since built for own use, cost includes necessary costs including labour/materials/overhead costs. Also includes interest expense incurred during construction process. Bulk Barn added interest incurred to other construction costs of Campus until ready for use. i. Capitalizing labour/materials/portion of int. expense 1. Increases assets 2. Decreases expenses 3. Increases net earnings Assume $600,00 labour costs, $1.3m materials/supplies, $100,000 int. Exp.: DR Building $2m CR Cash $2m 5. ​ ​Basket Purchase of Assets: ​ several long-lived assets such as land/building/equipment acquired in one transaction called ​basket purchase. ​Cost of each asset must be measured/recorded separately (since land doesn’t depreciate but buildings/equip does, at difference rates). EX)​ Bulk Barn paid $3m cash to buy building & land on which building is located. Appraising for market value totaling $3.15 indicated $1.89 for building and $1.26 for land. Total purchase price is then apportioned on the basis of relative market values: i. Building: 1.89/3.15 = 60% 1. 60% * $3m Total Cost = $1.8m ii. Land: 1.26/3.15 = 40% 1. 40% * $3m TC = $1.2m DR Building $1.8m DR Land $1.2m CR Cash $3m Relative Market Values = 1. Market Value / Total Market Value = ​% 2. %​ * Total Cost = ​RMV REPAIRS, MAINTENANCE, BETTERMENTS ➔ Most assets require expenditures, includes cash outlays for ordinary repairs/maintenance, major repairs, replacements, additions. ​Expenditure: ​payment of $$ to acquire goods/services, may be recorded as assets/expenses depending on where they benefit future periods or only current. Expenditures made after an asset are: 1. Ordinary Repairs & Maintenance, or Revenue Expenditures: ​recorded as EXPENSE in the ​current period​. ​ X)​ cleaning supplies for Bulk Barn. Ordinary Repairs​ - expenditures for normal operation upkeep of long-lived assets ​Revenue Expenditures​ (EXPENSE)​ - maintain the productive capacity of asset during ​current period only​, recorded as expenses. 2. Extraordinary Repairs & Betterments: ​expenditures that increase productive life, operating efficiency, capacity of asset. These ​capital expenditures​ are added to asset accounts as they add to company over number of accounting periods. EX) ​Bulk Barn’s renovation Extraordinary Repairs - ​infrequent expenditures that increase the asset’s economic usefulness in future Betterments - ​costs incurred to enhance productive/service potential of PPE Capital Expenditure​ (ASSET)​ - ​increases productive life, operating efficiency, capacity of asset. Recorded as increase in asset account, NOT expense. ***​Blurry line between Revenue (EXP) and Capital (ASS) Expenditures, so use judgement. **​MINOR = Revenue Expenditure MAJOR = Capital Expenditure USE, IMPAIRMENT, & DISPOSAL OF PPE Depreciation Concepts: ​portion of asset’s acquisition cost must be allocated as an expense to periods in which revenue is earned as result of use. ​Depreciation: ​process of allocating the acquisition cost of buildings/equipment over their useful lives. ​Carrying Amount (Book Value): Acquisition Cost of asset LESS Acc. Dep & any write-downs in AV. ​Residual (or Salvage) Value: ​estimate amount to be recovered LESS disposal costs, at end of estimated useful life. ex) value if sold to someone. Estimated amount to be recovered LESS any estimated costs of dismantling, disposal, sale. Estimated Useful Life: (Carrying Amount/Acquisition Cost) * Estimated Useful Life Depreciation Expense Calculation: ​requires… 1) Acquisition Cost (BV) 2) Estimated​ useful life to company 3) Estimated​ residual (or salvage) value at end of asset’s useful life Alternative Depreciation METHODS 1) Straight-Line: ​dep. exp/acc. dep. is a constant amount each year until hits residual value Depreciation Exp. = (Cost - Resid. Value) * (1/Useful Life) ^ Depreciable Cost ^Straight-Line Rate 2) Units-of-Production: ​allocates cost of asset over useful life based on relation of its periodic output​ to its ​total estimated output​. When this expense is used, depreciation exp. said to be ​variable expense​ as it VARIES directly with production/use. Depreciation Exp. = (Cost - Residual Value / Estimated Total Production) * Actual Production 3) Declining-Balance: ​allocates cost of asset over its useful life based on multiple of straight-line rate, often double declining rate. Decline in dep. exp. over time. With this method, useful life is lower. ***​carrying amount may be below residual value, so lower amount of dep. exp. Must be recorded so ​carrying amount = residual value Double-Declining Depreciation Exp. = (Cost - Acc. Dep.) * (2 / Useful Life)
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