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RSM219H1 (136)

Ch 8 Capital Assets.docx

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University of Toronto St. George
Rotman Commerce
Martin Ralph

Ch 8 Capital Assets 10/04/2013 12:02:00 PM Includes: land, real estate, buildings, equipment, vehicles, computers, patents, and so on that companies need to carry out operations -Requires a substantial mortgages or debt to finance them Objectives: -Users anticipate the future outflows of cash to replace them -Methods a company uses to depreciate its assets (on statement of earnings) -Future benefit - Cash received over several future periods Capital Assets Recognition -The company has the right to use it and a transaction has occurred 1) ° Value in use -the future value represented by the cash that will be received from the sales of products and services. 2) ° Residual value : Capital Assets’ disposal Value How are C.A. valued? 1) Historical Cost: - The original cost is recorded at the time of acquisition. Changes in the market value are ignored. - When it is used, its cost is expensed using a depreciation method. M.V. is only recognized when it is sold. - gain or loss on sale depends on the difference between the proceeds form the sale and the net book value at the time of sale - ° Net book value/ carrying value/ depreciation cost is the original cost less the portion that has been charged to expense in the form of depreciation. 2) Market value a. Replacement Cost (Buy) ° The amount that would be needed to acquire an equivalent asset -Replacement cost and the depreciation expense have a positive relationship -The gain and loss is determined by the difference between the proceeds from the sale and the depreciated replacement cost (price at sale) b. Net Realizable Value (Sell) -Assets are recorded at the amount from converting them to cash, from selling them -Depreciation is based on the NRV and is adjusted each time the asset is re-valued. - The G & L will be small Canadian Practice: Historical Cost ° Net Recoverable Amount: the total of all the future cash flows related to the asset, without discounting them to PV (an asset cannot be valued at more than the NRA) -If it carrying value > net recoverable amount, the carrying value must be written down must be written down and the difference recognized as an impairment loss. ° Capitalized Costs - Any cost that is necessary to acquire the asset and get it ready for use: Purchase price, Direct taxes on the purchase price, Interest cost, Legal costs associated, Shipping or transportation costs, Preparation and set up costs… -The purpose is to match the depreciation costs to the revenues that are generated while the assets are being used. -Land is a unique asset, its cost does not depreciate. Assigning costs to it means that costs will remain on the statement of financial position forever not the statement of earnings *Companies would like to expense as many costs as possible in order to reduce their taxable income and save on taxes. Capitalizing costs have to be waited until the assets are depreciated before the costs can be deducted. ° Basket Purchase -Acquiring several assets in one transaction 1) Each important component must be reported separately on the statement of financial position; 2) Assets that have different rate of depreciation have to be recorded separately in the accounts 3) some assets that don’t depreciate at all Assets Fair Value % Purchase $ Allocated Cost Land 250,000 25% 880,000 220,000 Timber 750,000 75% 880,000 660,000 1,000,000 880,000 -The F.V. of the land is 25% of the total F.V. -> 25%*880,000 is recorded in the land account, 660,000 is recorded in the timber account ° Interest Capitalization -the interest paid on the loan that finances the acquisition of a large C.A. - the interest costs can only be capitalized until the C.A is compete and ready for use - For assets that are purchased, interest costs are not capitalized since the time of acquisition is too short. Deprecation Concepts *Because the asset is expected to help generate revenue over multiple periods, companies don’t show the entire cost as an expense in the period of acquisition. Matching the cost and revenue results in a measurement of net profit or loss during those periods. -Estimate the asset’s useful life & the residual value at the end of the useful life ° Useful life is the periods over which the company will use the asset to generate revenues. ° Depreciation cost = Acquisition Cost (Capitalized cost) - Residual value ; -then it must be allocated to the years of useful life, a process of cost allocation Depreciation Methods 1. ° Straight-line method allocates the asset’s depreciation cost evenly over its useful life. -Since assets generate revenues evenly throughout its useful live, this method matches expenses to revenues • Rate of depreciation = 1/ # of years; 1/N * depreciation cost. 2. • Production Method/ Units of activity requires that the output or usefulness that will be derived from the asset be measurable as a specific quantity. It recognizes the usefulness or benefits derived from the C.A. Original Cost : $50,000 Estimated R.C. : $500 Usage: Year 1 2 3 4 5 Unit 4,000 5,000 6,000 4,500 3,000 22,500 Amortization Expense per Unit = Acquisition Cost – R.V. / Estimated total units of output = 50,000 – 500 / 22,500 = 2 per unit -It has no consistent or predictable pattern; depends on actual usage -Depreciation expense is determined by calculating the deprivation cost per unit , and multiply this cost per unit by the actual number of units used 3. • Accelerated or declining-balance method: Most benefit during early years. This method matches the more rapid depreciation in the early years of the asset’s life to the revenue. *Formula: (Acquisition Cost – Accumulated depreciation at the beginning of period) * Depreciation % = Depreciation expense * To establish the percentage: • double-declining-balance method: -Carrying value decreases each year -Amortization expense decreases each year -With 40%: the percentage selected is double the straight-line rate; Year Beginning NBV Beginning D.E. Ending NBV Depreciation 1 50,000 0 40%*50,000= B.NBV- D.E.= 20,000 30,000 2 30,000 20,000 40%*30,000 18,000 = 12,000 3 18,000 32,000 40%*18,000= 10,800 72,000 4 10,800 39,200 40%*10,800= 6,480
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