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Chapter 9

MGAB02H3 Chapter Notes - Chapter 9: Bulk Barn, Book Value, Intangible Asset


Department
Financial Accounting
Course Code
MGAB02H3
Professor
Liang Chen
Chapter
9

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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

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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
. EX) 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,
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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.
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