Chapter 9 Notes

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University of Toronto Scarborough
Financial Accounting
Liang Chen

Chapter 9 Reporting and Analyzing Long-Lived Assets Notes Property, Plant, and Equipment N long-lived resources that company owns that have physical substance (definite size and shape), are used in operations of business, and are not intended for sale to customers N provide benefits over many years, which arise from their use for production and sale of goods or services to customers, for rental to others, or for administrative purposes N critical to companys success because they determine companys production capacity and ability to satisfy customers Determining the Cost of Property, Plant, and Equipment N cost principle requires that PPE be recognized (recorded) at cost, which includes the following: the purchase price, less any discounts or rebates; the expenditure necessary to bring the asset to its required location and to make it ready for its intended use N these costs are capitalized (recorded as PPE) rather than expensed, if it is probable that company will receive an economic benefit in the future from the asset N operating expendituresexpenditures that benefit only current period; they are immediately matched against revenue as expense; they are required to maintain asset in its normal operating condition and often recur, although not always annually N capital expendituresexpenditures that benefit future periods; they are recorded as long-lived assets; normally larger than operating expenditures and occur less frequently N PPE are often subdivided into 4 classes: land, land improvements, buildings, equipment Land N all costs related to purchase of land, including such costs as survey and legal fees for closing the deal, are added to Land account N if additional work is required to prepare land for its intended use, such as clearing, grading, and filling, these costs are also recorded as capital expenditures in Land account N if land has building on it that must be removed to make site suitable for construction of new building, all demolition and removal costs, less any proceeds from salvaged materials, are added to Land account N when land has been purchased to construct a building, all costs that are incurred up to the time of excavation for the new building are considered to be part of the costs that are necessary to prepare the land for its intended use N once land is ready for its intended use, recurring costs, such as annual property taxes, are recorded as operating expendituresin other words, these costs are matched against the revenues that the land helps generate Land Improvements N land improvements are structural additions made to land, such as driveways, sidewalks, fences, and parking lots N land improvements decline in service potential over time and require maintenance and replacement due to which, improvements are recorded separately from land and are depreciated over their useful lives N when classifying costs, it is important to remember that one-time costs that are required for getting the land ready to use are always charged to Land account, not Land Improvements account Buildings N the cost of a building includes all costs that are directly related to its purchase or construction N when building is purchased, its cost includes purchase price, closing costs, and all costs to make building ready for its intended use including expenditures for remodelling rooms and offices, for replacing or repairing roof, floors, electrical wiring, plumbing N when new building is constructed, its cost consists of contract price plus payments made for architect fees, building permits, excavation costs, interest costs that are incurred specifically to finance construction project (interest that could not be avoided) Equipment N can include delivery equipment, office equipment, machinery, vehicles, furniture and fixtures, and other similar assets N includes the purchase price and all costs that are necessary to get equipment ready for its intended use N freight charges, insurance during transit that is paid by purchaser, and expenditures that are required in assembling, installing, and testing the equipment are all charged to Equipment account N annual costs such as licences and insurance are treated as operating expenditures when they are incurred Asset Retirement Costs N cost of PPE must include estimate of cost of any obligation to dismantle, remove, or restore long-lived asset when it is retired N costs such as these must be estimated (using present-value concepts) and added to the asset account and the other side of entry records liability for asset retirement obligation N these costs, and liability, are recorded in period when legal obligation is created, which can be at time asset is acquired, or later To Buy or Lease? N in a lease, a party that owns an asset agrees to allow another party to use the asset for an agreed period of time at an agreed price N lessora party that has agreed contractually to let another party use its asset N lesseea party that has made contractual arrangements to pay for the use of another partys asset N here are some advantages of leasing an asset versus purchasing it: 1. Reduced risk of the negative impact of obsolescence. Obsolescence is the process by which an asset becomes out of date before it physically wears out. Frequently, lease terms allow the party using the asset (the lessee) to exchange the asset for a more modern or technologically capable asset if it becomes outdate. This is much easier than trying to sell an obsolete asset. 2. 100 % financing. If a company borrows to purchase an asset, it is usually required to make a down payment of at least 20%. Leasing an asset does not require any money down, which helps to conserve cash. In addition, interest payments are often fixed for the term of the lease, unlike other financing which often has a floating interest rate.
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