Financial accounting the impact on decision makers 9e chapter 8

Chapter Operating Assets: Property, Plant, and Equipment, and Intangibles Operating Assets  Two categories of operating assets presented on the balance sheet:   Property, Plant and Equipment Intangible Assets Presented at their acquisition cost (historical cost)  Essential to a company’s long-term future    Used to produce the goods or services the company sells to customers Constitute the major productive assets of many companies LO Balance Sheet Presentation of Property, Plant, and Equipment  Balance sheet uses one line item for property, plant, and equipment and presents the details in the notes Acquisition of Property, Plant, and Equipment  Initially recorded at acquisition cost or original cost  Includes all cost normally necessary to acquire an asset and prepare it for its intended use  Purchase price  Taxes paid at time of purchase (for example, sales tax)  Transportation charges  Installation costs LO Group Purchase  Firm purchases several assets as a group and pays a lump-sum amount  Acquisition cost of each asset is separately measured on the basis of the proportion of the fair market value of each LO Example 8.1—Determining Cost When a Group of Assets Is Purchased  Assume that on January 1, ExerCo purchased a building and the land on which it is situated for $100,000 The accountant established the assets’ fair market value on January as follows:  Based on the estimated market values, purchase price should be allocated as follows: To land $100,000 × $30,000/$120,000 = $25,000 To building $100,000 × $90,000/$120,000 = $75,000 Example 8.1—Determining Cost When a Group of Assets Is Purchased (continued) The effect of the transaction can be identified and analyzed as follows: Capitalization of Interest  The interest on borrowed money should be treated as an expense of the period  If a company constructs an asset over a period of time and borrows money to finance the construction  The interest incurred during the construction period is not treated as interest expense  The interest must be included as part of the acquisition cost of the asset LO Land Improvements  The acquisition cost of land should be kept in a separate account because land has an unlimited life and is not subject to depreciation  Costs associated with land should be recorded in an account such as Land Improvements  Example: Costs of paving a parking lot and landscaping costs • Have a limited life • Should be depreciated over their useful lives Use and Depreciation of Property, Plant, and Equipment  Depreciation: allocation of the original cost of an asset to the periods benefited by its use  An asset’s decline in usefulness is related to:  Physical deterioration from usage or from the passage of time  Obsolescence factors such as changes in technology  The company’s repair and maintenance policies LO Research and Development Costs  Costs incurred in the discovery of new knowledge  According to FASB, all such expenditures must be treated as expenses in the period incurred  Patent account should not include the costs of research and development of a new product Amortization of Intangibles  Intangibles with finite life must be amortized  Recorded over the legal life or the useful life, whichever is shorter  Mostly recorded using the straight-line method  Intangibles with indefinite life are not amortized  Example: license trademark, goodwill, and broadcast LO 10 Example 8.9—Calculating the Amortization of Intangibles  Assume that Nike developed a patent for a new shoe product on January 1, 2014 The costs involved with patent approval were $10,000, and the company wants to record amortization on the straight-line basis over a five-year life with no residual value In this case, the useful life of the patent is less than the legal life Nike should record amortization over the useful life as $10,000/5 years = $2,000 The effect of the amortization for 2014 is as follows: Example 8.9—Calculating the Amortization of Intangibles  Some companies decrease (credit) the intangible asset account directly In that case, the preceding transaction is recorded as follows: Intangibles with Indefinite Life  If an intangible asset has an indefinite life, amortization should not be recognized Goodwill and Impairments  As per the FASB, goodwill should be treated as an intangible asset with an indefinite life and that companies should not record amortization expense related to goodwill  Each year, Assets with indefinite life should be checked for impairment  If an impairment has occurred, a loss should be recognized Goodwill and Impairments  Assume that Nike learns on January 1, 2015, when accumulated amortization is $2,000 (or the book value of the patent is $8,000), that a competing company has developed a new product that renders Nike’s patent worthless Nike has a loss of $8,000 and should record an entry to write off the asset as follows: IFRS and Intangible Assets  International standards are more flexible than the FASB standards in allowing the use of fair market values for intangible assets  Active market must exist  Fair value must be possible to determine  Research and development costs  FASB: all such costs should be treated as an expense  IFRS: Research costs be treated as an expense and development costs can be capitalized as an asset Exhibit 8.5—Long-Term Assets and the Statement of Cash Flows LO 11 Analyzing Long-term Assets—Average Life  Ratios are used to determine the age, composition, and quality of the operating assets  What is the average depreciable period (or life) of the company’s assets? Average Life = Property, Plant, and Equipment Depreciation Expense LO 12 Analyzing Long-term Assets— Average Age  Are assets old or new? Average Age = Accumulated Depreciation Depreciation Expense Analyzing Long-term Assets—Asset Turnover  How productive are the company’s assets? Asset Turnover = Net Sales Average Total Assets The Ratio Analysis Model What is the average life of the assets? What is the average age of the assets? How productive are the assets in producing revenue for the company? Gather the information about net sales and cost of goods sold Calculate the average life and average age Compare the ratio with prior years and with competitors Interpret the ratios The Business Decision Model If you were a lender, would you be willing to lend money to Nike, Inc., and use the operating assets as collateral for the loan? Gather information from the financial statements and other sources Compare the ratios with industry averages and look at trends Lend money or find an alternative use for the money Monitor the investment periodically End of Chapter [...]... as follows: Example 8. 7—Calculating the Gain on Sale of an Asset (continued)  After the July 1 entry, the balance of the Accumulated Depreciation—Machine account is $9,000, which reflects depreciation for the 2½ years from the date of purchase to the date of sale The effect of the transaction for the sale can be identified and analyzed as follows: Example 8. 8—Calculating the Loss on Sale of an Asset... as a percentage The straight-line rate for the ExerCo asset with a five-year life is as follows:  The second step is to double the straight-line rate, as follows:  The amount of depreciation for 2014  The amount of depreciation for 2015 Example 8. 4—Computing Depreciation Using the Units-of-Production (continued) The complete depreciation schedule for ExerCo for all five years of the machine’s life... $20,000 The machine’s estimated life would be five years, and its residual value at the end of 20 18 would be $2,000 The annual depreciation should be calculated as follows:  The book value at the end of 2014 Example 8. 2—Computing Depreciation Using the Straight-Line Method (continued)  The book value at the end of 2014 Units-of-Production Method  Depreciation is determined as a function of the number... ExerCo purchased a machine on January 1, 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000 ExerCo used the straight-line method of depreciation ExerCo sold the machine on July 1, 2016,for $10,000 The loss is calculated as follows: Example 8. 8—Calculating the Loss on Sale of an asset (continued)  The effect of the transaction for the sale can be identified... 1 ,80 0) The effect of the transaction for depreciation can be identified and analyzed as follows: Example 8. 7—Calculating the Gain on Sale of an Asset  Assume that ExerCo purchased a machine on January 1, 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000 ExerCo used the straight-line method of depreciation ExerCo sold the machine on July 1, 2016,for $12,400 The. .. Depreciation of Property, Plant, and Equipment  Methods    of depreciation: Straight-line Units-of-production Accelerated depreciation  The method chosen should be one that best matches the expense to the revenue generated by the asset Straight-Line Method  Allocates the cost of the asset evenly over time Example 8. 2—Computing Depreciation Using the Straight-Line Method  Assume that on January... in the Other Income or Expense category of the income statement LO 8 Gain on Sale of an Asset On January 1,2014, ExerCo purchased a machine 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000 ExerCo used the straight-line method of depreciation ExerCo sold the machine on July 1, 2016 Depreciation for the six-month period from January 1 to July 1, 2016, is $1 ,80 0... the expenditure qualifies as a capital expenditure, the cost of overhauling the machine should be added to the asset account Beginning in 2016, the company should record depreciation of $2,300 per year, computed as follows: Example 8. 6—Capitalizing Costs of a Major Repair (continued)  The effect of the transaction for the overhaul is as follows: Example 8. 6—Capitalizing Costs of a Major Repair (continued)... number of units the asset produces Example 8. 3—Computing Depreciation Using the Units-of-Production  ExerCo has estimated that the total number of units that will be produced during the asset’s five-year life is 18, 000 During 2014, ExerCo produced 4,000 units The depreciation per unit for ExerCo’s machine can be calculated as follows:  The book value at the end of 2014 Accelerated Depreciation Method ... 2015 2016 2017 20 18 revise estimate Depreciation Example 8. 5—Calculating a Change in Depreciation Estimate (continued)  In Example 8- 5, the effect of the transaction can be identified and analyzed as follows: Capital vs Revenue Expenditures LO 7 Capital vs Revenue Expenditures Example 8. 6—Capitalizing Costs of a Major Repair   At the beginning of 2016, ExerCo made a $3,000 overhaul to the machine, extending ... (continued)  The effect of the transaction for the overhaul is as follows: Example 8. 6—Capitalizing Costs of a Major Repair (continued)  The effect of the transaction to record depreciation... Example 8. 2—Computing Depreciation Using the Straight-Line Method (continued)  The book value at the end of 2014 Units-of-Production Method  Depreciation is determined as a function of the number... money should be treated as an expense of the period  If a company constructs an asset over a period of time and borrows money to finance the construction  The interest incurred during the construction