MGTB06 Chapter 9 Notes.docx

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University of Toronto Scarborough
Financial Accounting
G.Quan Fun

MGTB06 Chapter 9—Reporting and Interpreting Property, Plant and Equipment; Natural Resources and Intangibles Acquisition and Maintenance of Plant and Equipment Classification of Long-Lived Assets  long-lived assets or capital assets are tangible or intangible resources owned by a business and used in its operations to produce benefits over several years; tangible assets have physical substance while intangible assets have property ownership rights but not physical substance  because land does not become obsolete, it is never depreciated though it can be impaired in value Fixed Asset Turnover Ratio  fixed asset turnover ratio = net sales or operating revenues / average net fixed assets  measures the sales dollars generated by each dollar of fixed assets used, increasing rate over time signals more efficient fixed asset use  a lower or declining rate may indicate that a company is expanding (acquiring capital assets) in anticipation of higher sales whereas an increasing ratio could signal that a firm has cut back on capital expenditures because of an anticipated downturn in business Measuring and Recording Acquisition Cost  cost principles requires that all reasonable and necessary costs incurred in acquiring a long-lived asset, placing it in its operational setting and preparing it for use should be recorded in a designated asset account  the acquisition cost (the amount recorded for the purchase) is the net cash amount paid or, when non-cash assets are used up as payment, the fair market value of the asset given or asset received, whichever can be more clearly determined  interest is normally not recorded in capital assets however when construction is concerned, capitalized interest (amount of interest that is included in the cost of construction) is recorded until the facility is ready to use after which any interest costs are expensed  basket purchase is an acquisition of two or more assets in a single transaction for a single lump sum; accountants use current market value of acquired assets on the date of acquisition to apportion the single lump sum to the various assets in the basket Repairs, Maintenance and Betterments  an expenditure is the payment of money to acquire goods and services, may be recorded as assets or expenses depending on whether they benefit future periods or only the current period  expenditures made after an asset is acquired:  ordinary repairs and maintenance  expenditures for normal upkeep of long-lived assets, recorded as expenses in current period  also called revenue expenditures which maintain the productive capacity of the asset during the current accounting period only  do not directly lengthen the useful life of the asset, are recurring in nature  extraordinary repairs and betterments  extraordinary repairs are infrequent expenditures that increase the asset’s economic usefulness in the future  betterments are costs incurred to enhance the productive or service potential of a long-lived asset  they are capital expenditures which increase the productive life, operating efficiency or capacity of the asset and are recorded as increases in asset account, not as expenses Use, Impairment, and Disposal of Plant and Equipment Depreciation Concepts  all long-lived assets have limited useful lives, except land, long-lived assets represent the prepaid cost of a bundle of future services and benefits  depreciation is the process of allocating the acquisition cost of property, plant and equipment (but not land) over their useful lives by using a rational and systematic method; depletion refers to the allocation of the acquisition cost of natural resources while amortization refers to the depreciation of intangible assets  when an asset is depreciated, the amount remaining on the statement of financial position does not represent its current market value, depreciation is a process of cost allocation and not a process of determining an asset’s current market value or worth  the carrying amount of book value is the acquisition cost of an asset less accumulated depreciation and any write downs in asset value Remaining Life (at any day) = (Carrying Amount/Acquisition Cost) * Estimated Useful Life  depreciation expense is an estimate  estimated useful life is the expected service life of an asset to the present owner, this is not necessarily equal to the physical life of the asset  determination of useful life of a long-lived asset must conform to continuity assumption which states that the business will continue to pursue its commercial objectives and will not liquidate in the foreseeable future  residual or salvage value is the estimated amount to be recovered, less disposal costs, at the end of the estimated useful life of an asset Alternative Depreciation Methods  the three most common depreciation methods:  straight-line  units-of-production  declining (or diminishing) balance  straight-line depreciation is the method that allocates the cost of an asset in equal periodic amounts over its useful life  depreciation expense is a constant amount for every year and thus accumulated depreciation increases by an equal amount every year  carrying amount decreases by the same amount every year until it equals the estimated residual value (Cost – Residual Value) * (1/Useful Life) = Depreciation Expense  units-of-production is a method to allocate the cost of an asset over its useful life based on the relation of its periodic output to its total estimated output  depreciation expense is a variable expense because it varies directly with production or use and thus the carrying amount of accumulated amortization will also fluctuate from year to year (Cost – Residual Value)/Estimated Total Production * Actual Production = Depreciation Expense  declining-balance depreciation is the method that allocates the cost of an asset over its useful life based on a multiple of the straight-line rate, often two times  accelerated depreciation by which an asset is depreciated if it is considered to be more efficient or productive in its earliest years with a leveling off in later years  based on multiplying the asset’s carrying amount by a fixed rate that exceeds the straight-line (SL) method  double-declining-balance rate (Cost – Accumulated Depreciation) * (2/Useful Life) = Depreciation Expense  since accumulated depreciation increases each year, the carrying amount decreases and DDB rate is applied to a lower carrying amount each year resulting in a decline in depreciation expense over time  an adjustment must be made to ensure that in the last year too much depreciation is not recorded, in such a case depreciation expense is recorded so that the carrying amount equals residual value  companies that acquire many long-lived assets during the year may use the half-year rule which basically states that capital assets acquired at different dates throughout the year can be assumed to have been purchased around the middle year, thus can be depreciated for half a year; allowed as long as amount of depreciation expense is not materially misstated Changes in Depreciation Estimates  when it is clear that a depreciation estimate should be revised to a material degree or the asset’s cost has been changed, the undepreciated asset balance (less any residual value at that date) should be apportioned over the remaining estimated life from the current year into the future Managers’ Selection among Accounting Alternatives  the objective of financial reporting is to provide economic information about a business that is useful
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