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Chapter 8

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ACTG 2011
Beppino Pasquali

Accounting 2011Ankit MehraProf Pasqualli Chapter 8 Sept 9 2012 Capital asset They are resources that contribute to earning revenue over more than one period by helping an entity produce supply support or make available the GS it offers to its consumerso They are seldom bought or sold unlike inventory which is bought and sold in ordinary course of businesso There are 3 types of capital assetsProperty plant and equipment Tangible assets used to supply goods rented out to consumers or simply used for administrative purposes eg land building vehicles computers furniture Intangible assets Although not physical they contribute to earning revenue eg patents copyrights trademarks licensesGoodwill Paying more than the fair value of net assets during the mergeracquisition of another business Capital assets namely intangibles can have long and short lives For example land has a very long life whereas computer software may have a shorter life Historical cost accounting purpose is to match the cost of capital asset to the revenue earned over the life of the asset This can be used by stakeholders interested in evaluating historical performance such as calculating return on investment This information has limited usefulness when it comes to making projections or future oriented decisions historical cost of assets that are very old land purchased in 1950s for 25k being recorded today at same value in assets side of balance sheet has limited usefulness Alternatives to historical cost accounting for capital assets o Net realizable value NRV Amount received from selling an asset less selling costs Banks would find this information much more useful then historical cost of asset when giving out mortgage loans to entities Banks usually requires appraisal value of property when providing loans to entities NRV is less objective supported by facts and less reliable than historical cost since the amount is an estimate not supported by a transaction Obtaining a reasonable estimate for NRV is quite difficult because used and even new capital assets arent bought and sold very ofteno Replacement cost Amount the entity would have to pay to replace the capital asset Like NRV replacement cost is less objective than historical cost because there is no transaction supporting the amount charged for replacement in addition obtaining replacement for some assets which dont exist anymore is quite difficulto Valueinuseentity specific value IFRS term The net present value of the cash flow the asset will generate or save over its life For example valueinuse for an apartment building is the present value of rents less operating costs over the life of the building plus the amount the building could be sold for at the end of its life This Accounting 2011Ankit MehraProf Pasqualli information is useful for investors who are trying to figure out the value of a business Limitations of this method includeIndividual assets rarely generate cash flows on their own but instead interact with other assets to generate cash flowEstimating future cash flows of an asset requires making a lot of assumptions making the estimate unreliable When a capital asset is required it is always recorded on the balance sheet as a cost Cost should include all the costs incurred to purchase or build the asset and get it ready for useThis is also the same as the capitalized cost total cost incurred to acquire a capital asset and recorded as cost on the asset portion of the balance sheet Note that cost that is not related to acquisition of a capital asset like further maintenance and repair cannot be capitalizedDetermining whether certain costs should be capitalized or expensed can be difficult to assess and requires judgment The need for judgment introduces the possibility that different managers will account for similar costs differently in their self interesto If tax minimization or if management is concerned about overall bottom line is the entitys main objective they would expense as much and as many of the costs for acquiring an asset as reasonably possibleo If the entity prefers to maximize current income then it will capitalize as much as it can and defer expensing the costs Betterment Expenditures made to improve an existing capital asset to improve the future benefit associated with a capital asset Eg getting rust protection for a car the cost of rebuilding the engine to improve performance Since betterments provide a future benefit they are capitalized and depreciated over the remaining life of the asseto Expenditures enabling an asset to do what it is designed to do eg routine oil and filter change for a car should be expensed when incurred Changing a cars oil does not make the car better instead allows it to operate as intended by the manufacturer Insurance is not a capitalized asset as it not needed to get the capital asset running It should instead be listed as a prepaid asset and expensed as it is used over time Sometimes an entity would purchase a basket or bundle of assets at a single price where the price of individual assets would not be known eg buildingland 25 million Since it is difficult to decipher exactly what the market values of the land and building are separately managers have the flexibility to make the allocation as it suits their reporting objectiveso If the main concern is to minimize taxes managers will allocate more of the cost to the building because buildings can be deducted to reduce taxes whereas land cannoto If management is more concerned about increasing net income it could allocate more of the cost to land which is not depreciated
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