# Chapter 10 Amortization. FACTORS IN CALCULATING AMORTIZATION Illustration 10-6.

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Chapter 10 Amortization

FACTORS IN CALCULATING AMORTIZATION Illustration 10-6

AMORTIZATION METHODS Three methods of recognizing amortization are: 1. Straight-line, 2. Units of activity, and 3. Declining-balance. Each method is acceptable under generally accepted accounting principles. Management selects the method that is appropriate for their company. Once a method is chosen, it should be applied consistently.

STRAIGHT-LINE METHOD

Amortization is constant for each year of the asset's useful life

DECLINING-BALANCE METHOD The calculation of periodic amortization is based on a declining net book value (cost less accumulated amortization) of the asset. The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Net Book Value (at beginning of year) Straight-line Rate (x declining balance rate multiplier, if any) Amortization Expense

DECLINING-BALANCE METHOD Accelerated methods result in more amortization in early years and less in later years

UNITS-OF-ACTIVITY METHOD To use the units-of-activity method, 1) the total units of activity for the entire useful life are estimated, 2) the amount is divided into amortizable cost to calculate the amortization cost per unit, and 3) the amortization cost per unit is then applied to the units of activity during the year to calculate the annual amortization. Amortized Cost Total Units of Activity Amortizable Cost per Unit Units of Activity during the Year Amortization Expense Amortizable Cost per Unit

UNITS-OF-ACTIVITY METHOD Useful life is expressed in terms of total units of production or activity expected from the asset

If annual amortization is inadequate or excessive, a change in the periodic amount should be made. When a change is made, 1. there is no correction of previously recorded amortization expense and 2. amortization expense for current and future years is revised. REVISING PERIODIC AMORTIZATION Revised amortization expense = Net book value at time of revision – revised salvage value Remaining useful life

Ordinary repairs are expenditures to maintain the operating efficiency and expected productive life of the capital asset. They are debited to Repairs Expense as incurred and are often referred to as operating expenditures. Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the capital asset. 1. Expenditures are usually material in amount and occur infrequently during the period of ownership. 2. Since additions and improvements increase the company’s investment in productive facilities, they are debits to the capital asset affected, and are referred to as capital expenditures. EXPENDITURES DURING USEFUL LIFE

Capital assets may be disposed of by a) retirement b) sale, or c) exchange CAPITAL ASSET DISPOSALS

Amortization for the fraction of the year to the date of disposal must be recorded Amortization expensexxx Accumulated amortization xxx Calculate net book value Net book value = Cost - accumulated amortization 1 2

CAPITAL ASSET DISPOSALS Compare net book value to sale proceeds Proceeds > Net book value = gain (cr.) Proceeds < Net book value = loss (dr.) Record disposition, removing cost of asset and accumulated amortization, and record proceeds (if any) and gain or loss on disposition (if any) 3 4 Cashxxx Accumulated amortizationxxx Capital assetxxx Gain on disposalxxx

Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. Natural resources, frequently called wasting assets, have two distinguishing characteristics: 1. They are physically extracted in operations. 2. They are replaceable only by an act of nature. NATURAL RESOURCES

The acquisition cost of a natural resource is the cash or cash equivalent price necessary to acquire the resource and prepare it for its intended use. If the resource is already discovered, cost is the price paid for the property. ACQUISITION COST

AMORTIZATIONAMORTIZATION The units-of-activity method is generally used to calculate amortization, because periodic amortization generally is a function of the units extracted during the year.

ILLUSTRATION 10-23 FORMULA TO CALCULATE AMORTIZATION EXPENSE Amortizable Cost = (Cost – Residual Value + Restoration Costs) Total Estimated Units Amortization Cost per Unit Amortization Cost per Unit Number of Units Extracted and Sold Amortization Expense

10-24 ILLUSTRATION 10-24 STATEMENT PRESENTATION OF AMORTIZATION Accumulated Amortization, a contra asset account, is deducted from the cost of the natural resource in the balance sheet as follows:

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