Tools for Business Decision-Making Fourth Canadian Edition Financial Accounting: Prepared by: Peggy Coady Memorial University of Newfoundland & Catherine Seguin University of Toronto

Reporting and Analyzing Long-Lived Assets Chapter 9

Property, Plant, and Equipment Long-lived resources that: –Have physical substance –Are used in the operation of a business –Are not intended for sale to customers Chapter 9 3

Property, Plant, and Equipment Record at cost — cost principle Cost consists of all expenditures necessary to acquire asset and make it ready for its intended use. Chapter 9 4

Types of Expenditures Chapter 9 Operating expenditures –Current period expenditure –Immediately charged against revenue as an expense Capital expenditures –Capitalized as an asset –Increases the company’s investment in productive activity

Types of Expenditures Two criteria apply when determining operating or capital expenditure: –Frequency of cost — one time or recurring –Benefit period — the life of the asset or one year Chapter 9 6

Asset Retirement Costs In some companies there are significant costs associated with retiring a long-lived asset (e.g. decommissioning a nuclear power plant) These costs are estimated in advance and included as part of the cost of the asset Chapter 9 7

Land Cost of land includes –Purchase price –Closing costs such as title and legal fees Chapter 9 8 Note: Do not depreciate land since its useful life is indefinite. In addition, its usefulness and revenue producing ability generally remain intact, or increase.

Land Improvements The costs of structural additions made to land (e.g. paving, fencing) These are recorded separately from land Chapter 9 9

Buildings All necessary expenditures relating to the purchase or construction of a building When a building is purchased such costs include: –Purchase price –Closing costs (legal fees, title, insurance) Chapter 9 10

Buildings When a building is constructed, its cost consists of: –Contract price –Architect's fees –Building permits –Excavation cost –Interest costs during construction Chapter 9 11

Equipment Costs include: –Purchase price –Provincial sales tax –Freight charges and insurance during transit paid by the purchaser –Assembling –Installing and testing Chapter 9 12

Discussion Question What are some of the expenditures that would be included in the cost of a specialized piece of equipment that a company ordered and had delivered from another country? Chapter 9 13

Buy or Lease? Advantages –Reduced risk of obsolescence –100-percent financing –Income tax Terminology –Lessor—owner of asset for lease (e.g., landlord) –Lessee—company leasing asset from owner (e.g., tenant) Chapter 9 14

Buy or Lease? Operating lease –Treated as rental by lessee –Periodic payment (dr. rent expense/cr. cash) Finance lease –Treated as purchase by lessee (dr. asset/cr. liability) –Periodic payment (dr. liability and interest expense/cr. cash) Chapter 9 15

Depreciable Assets Revenue producing ability of an asset declines during its useful life because of: –Wear and tear –Obsolescence Chapter 9 16

Depreciation Allocating to expense the cost of an asset over its useful life in a rational and systematic manner, in accordance with the matching principle Process of cost allocation, not asset valuation Not a cash fund Chapter 9 17

Depreciation Methods Straight-line Diminishing-balance Units-of-production Chapter 9 18

Factors In Calculating Depreciation Chapter 9 19 Illustration 9-2

Example – Depreciation Methods A delivery van was bought on Jan. 1, 2009 Cost $33,000 Estimated residual value $3,000 Estimated useful life (in years) 5 Estimated useful life (in kilometres) 100,000 Chapter 9 20

Straight-Line Method Depreciation is constant for each year of the asset's useful life Chapter 9 21

Straight-Line Method Chapter 9 22 Illustration 9-3

Diminishing-Balance Method Accelerated methods result in more depreciation in early years and less in later years Depreciation rate = Straight-line rate x multiplier (if any) Straight-line rate = 100% ÷ Estimated useful life (in years) Chapter 9 23

Diminishing-Balance Method Illustration 9-5 Chapter 9 24

Units-of-Production Method Useful life is expressed in terms of total units of production or activity expected from the asset Chapter 9 25

Units-of-Production Method Illustration 9-7 Chapter 9 26

Discussion Question What would be the best choice of depreciation method for a fleet of company trucks if a company wanted the depreciation expense to track the “wear and tear” of the trucks? Chapter 9 27

Other Depreciation Issues Significant components Income tax Impairments Cost vs. revaluation model Chapter 9 28

Revising Periodic Depreciation Revisions needed if: –Capital expenditures during useful life –Impairment losses –Change in estimated useful life or residual value –Change in depreciation method Accounted for as a change in estimate (prospectively) Chapter 9 29

Disposals of Property, Plant, and Equipment Update depreciation –Depreciation for the fraction of the year to the date of disposal must be recorded Chapter 9 30 Depreciation Expense xxx Accumulated Depreciation xxx

Disposals of Property, Plant, and Equipment Calculate carrying amount Carrying amount = Cost – Accumulated depreciation Chapter 9 31

Disposals of Property, Plant, and Equipment Calculate gain or loss –Compare carrying amount to sale proceeds Chapter 9 32 Proceeds > carrying amount = Gain (Cr.) Proceeds < carrying amount = Loss (Dr.)

Disposals of Property, Plant, and Equipment Record disposal –Remove cost of asset and accumulated depreciation. Record proceeds (if any) and gain or loss on disposition (if any) Chapter 9 33 Cash xxx Accumulated Depreciation xxx Asset xxx Gain on Disposal xxx

Intangible Assets and Goodwill Rights, privileges Competitive advantages that result from ownership of long- lived assets that do not possess physical substance Chapter 9 34

Accounting for Intangibles Accounting for intangible assets parallels accounting for tangible assets For intangible assets depreciation is referred to as amortization Chapter 9 35

Types of Intangible Assets Finite lives –Patents –Research and development costs –Copyrights © Indefinite lives –Trademarks and trade names ™® –Franchises and licenses Chapter 9 36

Intangibles with Limited (Finite) Lives Patents –Exclusive right to produce for 20 years Research and development costs –All research costs are expensed –Development costs are capitalized only if associated with an identifiable, feasible product Chapter 9 37

Intangibles with Limited (Finite) Lives Copyrights © –Protection for the life of the creator + 50 years Chapter 9 38

Amortization for Intangibles Finite life –Amortize over shorter of Estimated useful life Legal life –Test for impairment Chapter 9 39

Intangibles with Indefinite Lives Trademarks and trade names ™® –Word, jingle, symbol that distinguishes business Franchises –Contractual agreement to sell products or services Licences –Operating rights Chapter 9 40

Goodwill Record only in an exchange transaction that involves purchase of entire business Excess of cost over fair market value of net assets (assets less liabilities) acquired Chapter 9 41

Amortization for Intangibles Indefinite life –Do not amortize –Test for impairment at least annually Chapter 9 42

Presentation of Long- Lived Assets Disclose –Balances and accumulated depreciation / amortization of major classes of assets –Depreciation / amortization methods as well as the amount of depreciation / amortization expense for the period –Impairment losses Chapter 9 43

Chapter 9 44 Analyzing Assets Return on assets –Measures net earnings generated per dollar of assets Higher is better Return on Assets = Net Earnings Average Total Assets

Asset turnover –Measures sales generated per dollar of assets Chapter 9 45 Analyzing Assets Asset Turnover = Net Sales Average Total Assets Higher is better

Chapter 9 46 Profit Margin Revisited

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