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McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Recording and Evaluating Capital Resource Activities:

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Presentation on theme: "McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Recording and Evaluating Capital Resource Activities:"— Presentation transcript:

1 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Recording and Evaluating Capital Resource Activities: Investing

2 Operational investments Plant assets Natural resources Intangible assets Because of the importance of operational investments, it is vital that we understand not only what these assets represent but also how companies record and report their acquisition, use and disposal

3 Plant Assets Often referred to as property, plant and equipment (PPE) The three steps to consider when describing the accounting process  1. acquisition  2. use  3. disposal

4 Acquisition Understand the difference between capital and revenue expenditures A capital expenditure creates the expectation of future benefit that apply beyond the current accounting period.--- capitalize or add to the cost of the plant asset rather than expensing it immediately Revenue expenditure (expenses) provide benefit exclusively during the current accounting period ----  Annual repairs, maintenance, utility bills, taxes, day to day operations

5 Assets Represent economic resources with expected future benefits become expenses as they are used up during construction --- all normal necessary costs incurred provide future benefits Capital expenditures include labor and material directly associated with construction --- permits, architects fees, taxes  Also, indirect costs – wages paid to security guards, insurance payments, interest on borrowed money.  Once completed, it becomes revenue expenditures

6 allocation Page 451 example of allocation

7 Depreciation Expenses associated with using PPE is called depreciation—it reduces the company’s assets and owners equity that is used to generate revenue Depreciation Expense200,000  Accumulated Depreciation200,000 Equipment at cost1,000,000 Less: accumulated depreciation ( 600,000 ) Equipment, Net$400,000

8 16-8 What is the Cost of Property, Plant, and Equipment? PPE is recorded as the total amount required to obtain and get the asset ready for its intended use Last more than one accounting period Purchase price Sales Tax Costs incurred to obtain (freight, etc.) Cost incurred to setup (installation, etc.) Land, building, and equipment

9 16-9 What are the Factors Affecting Depreciation Calculations? Cost Useful life---period of time over which a business expects to obtain economic benefits or total number of units (total miles)  Limited due to physical wear and tear or obsolescence ---changing technology Salvage value—residual value or fair market value Depreciation method—cost minus the salvage value equals the depreciable value

10 16-10 How is Depreciation Expense Calculated Using the Different Methods? Straight-line  (Cost – salvage value)/Useful life (time) = annual depreciation expense Units-of-production  (Cost – salvage value)/Useful life (units) = depreciation rate  Depreciation rate * annual usage = annual depreciation expense  Actual usage-benefit is tied to its use. More accurate—match the amt of expense recognized with actual rates of usage.

11 16-11 Depreciation Expense Calculated Using the Different Methods Continued Double-declining balance  2 * straight-line rate = DDB rate  DDB * carrying value = annual depreciation expense  Based on a constant percentage of declining balance. The multiplication of a constant rate by this declining balance yields the greatest amount of depreciation in the assets first year of use and a declining amount in each subsequent year.  Depreciation ceases when you reach salvage value

12 Exercise 1 a)Building b)Supplies or supplies expense c)Investment in land d)Office equipment e)Maintenance expense

13 Exercise 2 a)Capital expenditure b)Revenue expenditure c)Capital expenditure d)Capital expenditure e)Revenue expenditure

14 Exercise 5 a)(59,000 – 5,000)/6 = 9,000 per year b)(59,000 – 5,000)/45,000 = 1.20 per hour 1.20 * 8,000 hours = 9,600 year * 7,500 hours = 9,000 year 2 c) SL rate 1/6 * 2 = 33.33% doubled straight line rate 59,000 * 33.33% = 19,665 year 1 59,000 – 19,665* 33.33%=13,110 year 2

15 16-15 What if the Company Doesn’t Purchase (or sell) the Asset at the Beginning (or end) of the Year? Units-of-production  Multiple the depreciation rate by the actual usage Straight-line or double-declining balance  Use the mid-year convention or count the time that the asset was in use

16 Midyear Convention Companies making numerous plant asset purchases and disposals spread out evenly during the course of the fiscal year frequently use the midyear convention, which reflects depreciation expense for each asset as if it were purchased or disposed of exactly halfway through the company’s fiscal year.

17 Illustration --- page 457 PCs to Go, with a December 31 year-end, purchases its delivery truck in April 2010 and expects to dispose of it five years later in April Straight – line depreciation for each fiscal year of use would be as follows: Refer to page 457

18 Revision of Estimates A company originally assigns a useful life of seven years to a computer and, one year after the date of the purchase, realizes that it will have to replace the computer after a total of three year. When it becomes clear that they need to make an adjustment– do the following---

19 Revision of estimates Assume that on January 1, 2010, a company purchases and begins to use office equipment costing $12,000, with an expected useful life of 10 years and a salvage value of $2,000. Assuming the business uses the straight-line method of depreciation for the asset, accumulated depreciation at December 31, 2012, would be $3,000

20 16-20 What is the Process Involved in Asset Disposals? Record depreciation to date of disposal Remove the cost of the asset (CR) and the accumulated depreciation (DR) from the records Record the assets received (DR) if applicable Record the cash paid (CR) if applicable Record the loss incurred (DR) if applicable Record the gain (CR) if applicable

21 16-21 How Can a Company Dispose of an Asset Before its Useful Life is Over? Discard---it is necessary to record a loss at the date of the disposal  Discard equipment that cost 50,000 with a 40,000 of accumulated depreciation at the date of the last balance sheet. Must pay $1,000 to have it removed. Assets = Liabilities + Owner’s Equity 2,000 =2,000 Depreciation expense 2,000 Accumulated Depreciation2,000

22 Problem continued After the entry is posted, the accumulated depreciation account will have a $42,000 credit balance (previous balance of $40,000 plus $2,000. Second, we must recognize the removal of the equipment (book value = $8,000) and cash: Assets = Liabilities + Owners Equity (8,000) = (9,000) (1,000)

23 Journal Entry Accumulated Depreciation42,000 Loss on Disposal9,000  Equipment50,000  Cash1,000

24 Sell Must be sold for equal, less than, or greater than. Recall when more net assets are received than are given up, a gain results. A loss results when fewer net assets are received than are given up.

25 Example Cost of Asset$80,000 Accumulated depreciation (60,000) through date of sale Carrying Value at date of sale$20,000 Assets = Liabilities + Owner’s Equity +20, ,000 Selling for the same amount of net assets

26 Journal Entry Cash20,000 Accum Dep60,000 Equipment80,000

27 16-27 Exchange (Trade-In) Example We have a computer that originally cost $6,000 and has accumulated depreciation of $4,500. We will trade-in this computer for a new computer with a list price of $10,000. The computer company will give us a trade-in allowance of $2,000. Book value = $6,000 - $4,500 = $1,500. Cash payment required = $10,000 - $2,000 = $8,000

28 16-28 Trade-in Example Continued Computer received = $10,000 Less assets given up = $9,500 Gain = $500 Entry: Computer (new)10,000 Accumulated depreciation 4,500 Computer (old)6,000 Cash8,000 Gain 500

29 16-29 What are Depletion and Amortization? Depletion  The cost of a natural resource is allocated to expense  Typically, units-of-production method used Amortization  The cost of an intangible asset is allocated to expense  Typically, straight-line method is used


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