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LONG-LIVED ASSETS AND DEPRECIATION Chapter 7 12-1 © 2005 McGraw-Hill Ryerson Limited.

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Presentation on theme: "LONG-LIVED ASSETS AND DEPRECIATION Chapter 7 12-1 © 2005 McGraw-Hill Ryerson Limited."— Presentation transcript:

1 LONG-LIVED ASSETS AND DEPRECIATION Chapter © 2005 McGraw-Hill Ryerson Limited.

2 Characteristics:   Used in the operations of a company.   Have a useful life greater than one accounting period.   May be classified as Tangible or Intangible. Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

3   Also referred to as Property, Plant and Equipment or as Fixed Assets.   Examples: buildings, land, equipment, leasehold improvements, vehicles, and natural resources. Tangible Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

4   Lack physical substance.   Examples: patents, trademarks, and copyrights.   Goodwill is also an intangible capital asset but it is shown separately on the balance sheet. Intangible Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

5   Capital assets are recorded at cost which, includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use. Cost of Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

6 Capitalize A cost that is added to an asset account, as distinguished from being expensed immediately. A cost that is added to an asset account, as distinguished from being expensed immediately © 2005 McGraw-Hill Ryerson Limited.

7   An expenditure to make a capital asset more efficient or productive and/or extend the useful life of the capital asset beyond original expectations.   Examples: major overhauls of machinery, roof replacements, and plant expansions. Betterments © 2007 McGraw-Hill Ryerson Ltd.

8   Is not subject to amortization.   Cost of land includes:   Purchase price   Legal fees   Real estate commissions   Accrued property taxes   Payments for surveying, grading, draining, and clearing the land   Assessments by local governments Land © 2007 McGraw-Hill Ryerson Ltd.

9   Assets that increase the usefulness of the land but have a limited life.   Costs are charged to a separate asset account.   Costs are amortized over the period they benefit. Land Improvements © 2007 McGraw-Hill Ryerson Ltd.

10   Costs include all expenditures to make the building ready for its intended use.   Costs are amortized over the period they benefit. Buildings © 2007 McGraw-Hill Ryerson Ltd.

11   Costs of alterations or improvements to leased property.   Costs are amortized over the life of the improvements or the life of the lease, whichever is shorter.   Examples include flooring, painting, storefronts, and partitions. Leasehold Improvements © 2007 McGraw-Hill Ryerson Ltd.

12   Costs include all expenditures normal and necessary to purchase it and prepare it for its intended use.   Costs are amortized over the periods they benefit. Machinery and Equipment © 2007 McGraw-Hill Ryerson Ltd.

13   A process of systematically allocating the cost of a capital asset to expense over its estimated useful life.   Depreciation does not measure the decline in value or deterioration of an asset.   Depreciation begins to be recorded when the asset is put into use. Depreciation © 2007 McGraw-Hill Ryerson Ltd.

14   Capital assets help the organization earn revenues over several accounting periods.   The cost of these assets is depreciated (spread out) over these same periods. Cost Useful life Depreciation © 2007 McGraw-Hill Ryerson Ltd.

15 Factors relevant in determining amortization: Cost Residual value Useful life Depreciation © 2007 McGraw-Hill Ryerson Ltd.

16 The most commonly used methods are: Straight-line Units-of-production Double-declining balance Depreciation Methods © 2007 McGraw-Hill Ryerson Ltd.

17 The same amount is expensed each period of the asset’s useful life. Straight-line depreciation expense = Cost – Estimated residual value Estimated useful life Straight-Line Method © 2007 McGraw-Hill Ryerson Ltd.

18 A piece of shoe-inspection machinery is purchased on January 1, The relevant data is as follows: Cost $10,000 Estimated residual value -1,000 Cost to be amortized $9,000 Estimated useful life: Accounting periods 5 years Units inspected 36,000 shoes Illustration © 2007 McGraw-Hill Ryerson Ltd.

19 Straight-line amortization expense = Cost – Estimated salvage value Estimated useful life Illustration: Straight-Line Method $10,000 – $1,000 5 years = = $1,800/ year © 2007 McGraw-Hill Ryerson Ltd.

20 Illustration: Straight-Line Method The annual adjusting entry to record amortization on this equipment would be: Amortization Expense, equipment 1,800 Accumulated Amortization, –equipment 1, Equipment$10,000$10,000$10,000$10,000$10,000 Less: Acc. Amort. 1,800 1,800 3,600 3,600 5,400 5,400 7,200 7,200 9,000 9,000 Book Value $8,200$6,400$4,600$2,800$1,000 © 2007 McGraw-Hill Ryerson Ltd.

21 Amortization per unit = Cost – Estimated residual value Total estimated units of production   This method is employed when the use of an asset varies greatly from one period to the next.   The amount charged to expense is based on the usage of the asset. Annual amortization expense = Actual production x Amortization per unit Units-of-Production Method © 2007 McGraw-Hill Ryerson Ltd.

22 Amortization per unit (shoe) Illustration: Units-of-Production Method $10,000 – $1,000 36,000 units (shoes) = $.25/shoe Assume actual production is as follows: Units (shoes) 7,000 8,000 9,000 7,000 6,000 x.25 x.25 x.25 x.25 x.25 Amortization $1,750 $2,000 $2,250 $1,750 $1,250* = *Maximum amortization allowed since 36,000 units have been produced. © 2007 McGraw-Hill Ryerson Ltd.

23 Illustration: Units-of-Production Method Equipment$10,000$10,000$10,000$10,000$10,000 Less: Acc. Amort. 1,750 1,750 3,750 3,750 6,000 6,000 7,750 7,750 9,000 9,000 Book Value $8,250$6,250$4,000$2,250$1,000 © 2007 McGraw-Hill Ryerson Ltd.

24  This method yields larger amortization expenses in the early years of an asset’s life and smaller charges in later years.  A constant rate, up to twice the straight-line rate, is applied to the asset’s beginning of the period book value. Declining-Balance Method © 2007 McGraw-Hill Ryerson Ltd.

25 Steps: 1. Compute the double-declining balance rate.* rate = 2 / (estimated life in years) rate = 2 / (estimated life in years) 2. Multiply the rate by the asset’s opening book value. amortization expense = rate x book value amortization expense = rate x book value *Note: Salvage value is not used in this calculation. Double-Declining Balance Method © 2007 McGraw-Hill Ryerson Ltd.

26 Illustration: Double-Declining-Balance Method Rate = 2 / 5 years x 100% = 40% per year Year Book Value at start of period Amortization Expense Accumulated Amortization Book Value at end of period 2011$10,000 40% x 10,000 = $4,000 $4,000 $4,000 $6,000 $6, ,000 6,000 40% x 6,000 = 2,400 6,400 6,400 3,600 3, % x 3,600 = 1,440 7,840 7,840 2,160 2, % x 2,160 = 864 8,704 8,704 1,296 1, (maximum) 296 (maximum) 9,000 9,000 1,000 1,000 (salvage value) © 2007 McGraw-Hill Ryerson Ltd.

27 Illustration: Double Declining Balance Method Equipment$10,000$10,000$10,000$10,000$10,000 Less: Acc. Amort. 4,000 4,000 6,400 6,400 7,840 7,840 8,704 8,704 9,000 9,000 Book Value $6,000$3,600$2,160$1,296$1,000 © 2007 McGraw-Hill Ryerson Ltd.

28 Period Straight- line Units-of- production Double- Declining Balance 2011$1,800$1,750$4, ,8002,0002, ,8002,2501, ,8001, ,800 1,800 1,250 1, $9,000$9,000$9,000 Comparison of Methods © 2007 McGraw-Hill Ryerson Ltd.

29  Assets may be purchased or disposed of at any time during the year.  Amortization for a partial year is recorded when the purchase or disposal is made at a time other than the beginning or end of the accounting period. Partial-Year Amortization © 2007 McGraw-Hill Ryerson Ltd.

30 Methods: 1. Nearest whole month  If the asset is in use for more than half of the month, amortization is calculated for the whole month.  If the asset is in use for less than half of the month, amortization is not calculated for the month. 2. Half-year rule  Six months’ amortization is recorded regardless when an asset is acquired or disposed of. Partial-Year Amortization © 2007 McGraw-Hill Ryerson Ltd.

31 Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. Calculate amortization for the first year using the: 1.Straight-line method. 2.Double declining balance method. © 2007 McGraw-Hill Ryerson Ltd.

32 Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. Straight-line amortization expense = Cost – Estimated residual value Estimated useful life = $4,000 – $400 3 years X 8/12 year = $800 X Portion of year © 2007 McGraw-Hill Ryerson Ltd.

33 Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. DDB amortization expense = = = $1778 (rounded) DDB rate x Cost x Portion of year (2 x 1/3) x $4,000 x 8/12 © 2007 McGraw-Hill Ryerson Ltd.

34 Amortization rates for current and future periods may be revised if there is a change in an asset’s: Amortization rates for current and future periods may be revised if there is a change in an asset’s: 1. Estimated residual value and/or useful life. or 2. Cost due to betterments. Revising Amortization Rates © 2007 McGraw-Hill Ryerson Ltd.

35   The unamortized cost of the asset is amortized (spread) over the remaining life of the asset.   This is considered to be a change in an accounting estimate and not an error. Changes in Estimated Useful Life and/or Estimated Salvage Value © 2007 McGraw-Hill Ryerson Ltd.

36 Example: Straight-line Method Revised amortization for remaining years = Remaining book value Revised residual value Revised remaining useful life Changes in Estimated Useful Life and/or Estimated residual Value © 2007 McGraw-Hill Ryerson Ltd.

37 Capital assets may be disposed of for a variety of reasons such as: Capital assets may be disposed of for a variety of reasons such as: 1. Obsolescence 2. Wear and tear 3. Damage 4. Changing business plans Disposal of Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

38 Accounting for disposal involves: Accounting for disposal involves: 1. Recording of amortization up to date of disposal. 2. Removal of asset and associated accumulated amortization from the accounts. 3. Recording any cash received or paid in the disposal. 4. Recording any gain or loss on disposal. Disposal of Capital Assets © 2007 McGraw-Hill Ryerson Ltd.

39  Tangible capital assets such as standing timber, mineral deposits, and oil fields.  Are recorded at cost, which includes all expenditures necessary to acquire and prepare the resource for use. Natural Resources © 2007 McGraw-Hill Ryerson Ltd.

40 Amortization per unit = Cost – Estimated residual value Total units of capacity Amortization expense = Units extracted x Amortization per unit Natural resources are amortized based on units extracted or depleted. Natural Resources © 2007 McGraw-Hill Ryerson Ltd.

41  Have no physical substance.  Are used in operations.  Are recorded at cost when purchased.  Are amortized over their estimated useful life.  Examples include patents, trademarks, and copyrights. Intangible Assets © 2007 McGraw-Hill Ryerson Ltd.

42 Amortization  Estimated useful life may be affected by legal, regulatory, competitive, or other factors.  Only the straight-line method is used. Intangible Assets © 2007 McGraw-Hill Ryerson Ltd.

43 Patents Grants given by the federal government to an inventor (U.S.) bestowing the exclusive right to produce and sell the invention for 17 years. Grants given by the federal government to an inventor (U.S.) bestowing the exclusive right to produce and sell the invention for 17 years. Depreciation is calculated on its useful life for the 17 years, whichever is shortest. Depreciation is calculated on its useful life for the 17 years, whichever is shortest © 2005 McGraw-Hill Ryerson Limited.

44 Copyrights Exclusive right to reproduce and sell a book, musical composition, film and similar items for 75 years. (U.S.) Exclusive right to reproduce and sell a book, musical composition, film and similar items for 75 years. (U.S.) Amortization is the shorter of the 75 years or the economic life. Amortization is the shorter of the 75 years or the economic life © 2005 McGraw-Hill Ryerson Limited.

45 Trademarks Distinctive identification of a manufactured product or of a service taking the form of a name, a slogan, a sign, a logo, or an emblem. Distinctive identification of a manufactured product or of a service taking the form of a name, a slogan, a sign, a logo, or an emblem © 2005 McGraw-Hill Ryerson Limited.

46 Franchise Privileges granted by a government, manufacturer, or distributor to sell a product or service in accordance with specified conditions. Privileges granted by a government, manufacturer, or distributor to sell a product or service in accordance with specified conditions © 2005 McGraw-Hill Ryerson Limited.

47 Leaseholds The right to use a fixed asset for a specified period of time, typically beyond 1 year. The right to use a fixed asset for a specified period of time, typically beyond 1 year. Sometimes included with plant and equipment assets. Sometimes included with plant and equipment assets © 2005 McGraw-Hill Ryerson Limited.

48 Leasehold Improvements Tenant spends money to improve the leased property. Tenant spends money to improve the leased property. Not permitted to be removed from the premises when a lease expires. Not permitted to be removed from the premises when a lease expires. EX. Panels, walls, air conditioning, storefronts, flooring EX. Panels, walls, air conditioning, storefronts, flooring © 2005 McGraw-Hill Ryerson Limited.

49 End of Chapter © 2007 McGraw-Hill Ryerson Ltd.


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