BSAD 221 Introductory Financial Accounting Donna Gunn, CA

Types of Assets Long-lived assets used in the operation of a business are divided into categories: Property, Plant and Equipment (Tangible long-lived assets) Intangible Assets

Measuring and Recording Acquisition Cost Acquisition cost includes: the purchase price and all expenditures needed to prepare the asset for its intended use. In most circumstances, it does not include financing charges

Land A business purchases land for a new production facility at a cost of $300,000. It also pays: $10,000 in real estate commission, $8,000 in back property tax, $5,000 for removal of an old building, $1,000 survey fee, and $260,000 to prepare the foundation for the factory What is the cost of the land?

Land Purchase price of land$300,000 Add related costs: Real estate commission$10,000 Back property tax 8,000 Removal of buildings 5,000 Survey fees 1,000 Total cost of land$324,000

Acquisition Cost – Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not amortizable.

Acquisition Cost – Buildings / Equipment Purchase Price Legal fees related to purchase Repair / construction costs required for use Installations costs Transportation costs Any costs required to bring the asset to use

Acquisition for Cash On June 1, WestJet Airlines purchased aircraft for $60,000,000 cash. Aircraft$60,000,000 Cash$60,000,000

Acquisition for Debt On June 14, WestJet Airlines purchased aircraft for $1,000,000 cash and a $59,000,000 note payable. Aircraft$60,000,000 Cash $ 1,000,000 Note Payable59,000,000

Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. Acquisition for Noncash Consideration

On July 7, WestJet purchased a $60,000,000 aircraft for $10,000,000 cash plus 2,000,000 common shares of a market value of $25 each. Aircraft$60,000,000 Cash $10,000,000 Note Payable 50,000,000

Lump-Sum (or Basket) Purchases of Assets Great-West Lifeco Inc. paid $2,800,000 for a combined purchase of land and a building. The land is appraised at $300,000 and the building at $2,700,000. How much of the purchase price is allocated to land and how much to the building?

Lump-Sum (or Basket) Purchases of Assets Appraised % of Purchase Assigned Asset Value Price Cost a b* c b × c Land $2,700,000 90% Building 300,000 10% Total $3,000, % *$2.7M/$3M

Lump-Sum (or Basket) Purchases of Assets Appraised % of Purchase Assigned Asset Value Price Cost a b c b × c Land $2,700,000 90% $2,800,000 $2,520,000 Building 300,000 10% $2,800, ,000 Total $3,000, % $2,800,000

Does the expenditure increase capacity or efficiency or extend useful life? Capital Expenditures: Record an asset Expenses: Record an expense Capital Expenditure versus an Immediate Expense Yes No

Capital Expenditure versus an Immediate Expense Record an Asset for Capital Expenditures Extraordinary repairs: Major engine overhaul Modification of body for new use of truck Addition to storage capacity of truck Record Repair and Maintenance Expense Ordinary repairs: Repair of transmission or other mechanism Oil change, lubrication, etc. Replacement tires, windshield Paint job

Amortization – systematially allocates the cost of an asset to the period benefited by their use. Cost Allocation (Unused) Balance Sheet (Used) Income Statement Expense Amortization Acquisition Cost

Amortization Expense Income Statement Accumulated Amortization Amortization for the current year Total of amortization to date on an asset Amortization Balance Sheet

Net Book Value Book Value is NOT Market Value Cost – Accumulated Amortization = Book value

Amortization Concepts The calculation of amortization requires three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value.

Alternative Amortization Methods Straight-line Units-of-production Double declining balance (diminishing balance)

Straight-Line Method At the beginning of the year, WestJet purchased an aircraft $45,000,000 cash. The equipment has an estimated useful life of 25 years and an estimated residual value of $1,400,000. Cost - Residual Value Life in Years Amortization Expense per Year Amortization Expense per Year ==

= = $1,744,000 $45,000,000 - $1,400, years Cost - Residual Value Life in Years Amortization Expense per Year = Straight-Line Method

Net Book Value DepreciationAccumulated Undepreciated ExpenseAmortization Balance Year(debit)(credit)Balance(book value) 45,000,000 11,744,000 43,256,000 21,744,000 3,488,00041,512,000 31,744,000 5,232,00039,768,000 5,232,000

Amortization Rate = Cost - Residual Value Estimated Total Production Step 1: Step 2: Amortization Expense = Amortization Rate × Actual Annual Production Units-of-Production Method

WestJet purchases an aircraft. Cost - $45,000,000 cash The aircraft has 87,200 fight hours of useful life. Estimated residual value of $1,400,000. If the aircraft is used for Year 1 - 3,460 flight hours Year flight hours What is the amount of amortization expense?

Step 1: Step 2: Amortization Expense = $500/hour x 3,460 hours = $1,730,000 Amortization Rate = $45,000,000 - $1,400,000 87,200 hours = $500 / hour Units-of-Production Method

Net Book Value AccumulatedUnamortized Amortization Balance YearHoursExpenseBalance(book value) 45,000, ,4601,730,000 43,270, ,6001,800,0003,530,00041,470, ,3501,675,0005,205,00039,795,000

Annual Amortization Expense Net Book Value () Useful Life in Years 2 = × Cost – Accumulated Amortization Declining balance rate of 2 is double-declining-balance (DDB) rate. Annual computation ignores residual value. Double-Declining-Balance Method

WestJet purchased an aircraft for $45,000,000 cash. Estimated useful life of 25 years Estimated residual value of $1,400,000. Calculate the amortization expense for the first two years. Double-Declining-Balance Method

Annual Amortization expense Net Book Value () Useful Life in Years 2 = × Double-Declining-Balance Method

Annual Amortization expense Net Book Value () Useful Life in Years 2 = × Double-Declining-Balance Method Year 1 Amortization: Year 2 Amortization: () $45,000,000 × 25 years 2 = $3,600,000 () ($45,000,000 – $3,600,000) × 25 years 2 = $3,312,000

() ($45,000,000 – $6,912,000) × 25 years 2 = $3,047,000 Double-Declining-Balance Method AmortizationAccumulatedUnamortized ExpenseAmortizationBalance Year(debit)Balance(book value) 45,000,000 13,600,000 41,400,000 23,312,0006,912,00038,088,000 33,047,0409,959,04035,040,960