1. CHAPTER 9
Capital Assets

2. Agenda Learning goals Vocabulary Property, Plant, and Equipment
Amortization
Natural resources
Intangible assets

3. Learning Goals
Apply the cost principle to property plant, and equipment
Explain and calculate amortization
Revise periodic amortization
Account for the disposal of property, plant and equipment
Calculate and record amortization of natural resources
Identify the basic accounting issues for intangible assets
Illustrate the reporting and analysis for long-lived assets

4. Vocabulary Capital assets Tangible assets Intangible assets
Natural resources
Capital expenditures
Operating expenditures

5. CAPITAL ASSETS Capital assets (fixed assets) are:
Long-lived
Used in the operations of a business
Not intended for sale to customers.
Capital assets have two classes:
1. Tangible (can touch it)
2. Intangible (can’t touch it)

6. TANGIBLE CAPITAL ASSETS
Tangible capital assets include:
property, plant and equipment like:
Land and land improvement (driveways, parking lots)
Building (stores, offices…)
Equipment, machinery and delivery equipment
natural resources such as mineral deposits, oil and gas reserves, and timber

7. INTANGIBLE CAPITAL ASSETS
What are they?
Patents, copyrights, sports contracts, and trademarks, goodwill
Intangible capital assets provide future benefits through the special rights and privileges they possess. 

8. Determining Cost Cost principle: These costs are capital expenditures
Include all costs to acquire asset and make it ready for use
Include purchase price, freight costs paid, testing and installation costs
These costs are capital expenditures
Benefit future periods
Costs that benefit only the current period are called operating expenditures

9. Types of Long-lived Assets
Land includes:
Purchase price
Closing costs such as legal fees and surveys
Costs of preparing land for intended use
Unlimited useful life and is not amortized
Land improvements:
Structural additions to land such as fences, parking lots, landscaping
Have limited useful lives
Recorded separately from land and amortized

10. Types of Long-lived Assets
Buildings – cost includes:
Purchase price and closing costs
Costs to make building ready for its intended use, such as remodelling and repairs
Equipment – cost includes
Purchase price
Freight charges and insurance during transit
Assembling, installing, testing

11. Types of Long-lived Assets
Basket purchases: is when property, plant and equipment are purchased together for a single price.
Need to know the cost of each individual assets in order to journalize it and amortize it.
Determining individual cost based on the relative fair market value

12. Allocating cost in a basket purchase
Sega company acquired a building and land on July 31 for $300,000, paying $50,000 in cash and incurring a mortgage payable for the balance.
Fair Market Value
Allocated Percentage
Allocated Cost
Land
$120,000
37.5% ($120,000/$320,00)
$112,500 ($300,000*37.5%)
Building
$200,000
62.5% ($200,000/$320,00)
$187,500 ($300,000*62.5%)
Totals
$320,000
100%
$300,000
Debit land for 112,500 and debit building for 187,500 and credit cash for 50,000 and credit mortgage payable for 250,000

13. (Depreciation - Review)
WHY AMORTIZATION?
(Depreciation - Review)
During an asset’s life, its usefulness may decline because of usage or obsolescence.
Amortization is the process of allocating to expense the cost of a capital asset over its useful life.
Amortization is designed to match expenses with revenues in accordance with the matching principle.
Recognition of amortization does not result in the accumulation of cash for the replacement of the asset, nor the use of cash, although an expense is recognized.
Land is the only capital asset that is not amortized.

14. AMORTIZATION METHODS Three methods of recognizing amortization are:
Straight-line,
Declining-balance (includes CCA), and
Units of activity.
Each method is acceptable under GAAPs.
Management selects the method that is appropriate for their company, it should be applied consistently.

15. Annual Rate of Amortization
1. STRAIGHT-LINE METHOD
Historical Cost
Salvage Value
Annual Rate of Amortization
Useful Life
(in years)

16. 1. STRAIGHT-LINE METHOD

17. DECLINING-BALANCE METHOD
Based on a declining book value (cost less accumulated amortization).
The amortization rate remains constant, but the net book value declines each year.
Book Value
(at beginning of year)
Declining balance rate
Amortization Expense
(for the year)

18. DECLINING-BALANCE (cont.)
If you aren’t given a rate for declining balance, use the following formula:
NEW!
100% .
Useful Life
Rate =
Example: Business buys $10,000 piece of equipment with a salvage value of $1,000 is expected to last for 10 years.
However, management feels that the DECLINING BALANCE METHOD is best for amortizing this asset.
100% .
10 years
= 10%

19. DECLINING-BALANCE METHOD

20. Units-of-Activity Method
Useful life expressed as total units of production or activity
Must estimate the total units of activity that will be obtained from asset ÷
Total Estimated Units of Activity =
Amortizable Cost per Unit
Amortizable Cost
Amortizable Cost per Unit x
Units of Activity during the Year =
Annual Amortization Expense

21. UNITS-OF-ACTIVITY METHOD
EXAMPLE (assume the following):
Mine of 1,000,000 m3 of ore
Cost of finding, dropping a shaft and preparing for use: $50,000,000
This year we harvested 75,000 m3 of ore.
Total Cost of Resource – Salvage Value
Total Units Available
Amortization Cost per Unit
Amortization Cost per Unit X
Units Used
Amortization Cost this Period

22. UNITS-OF-ACTIVITY METHOD

23. Comparison of Amortization Method

24. REVISING AMORTIZATION Change in Amounts or Speed
If annual amortization is inadequate or excessive, a change should be made.
When a change is made,
There is no correction of previously recorded amortization expense, and
Amortization expense for current and future years is revised using the normal formulas.
When asset is bought/sold part way through a year, that year’s amortization must be prorated.

25. REVISING AMORTIZATION
Change in Method
If you decide to change the amortization method, a prior period adjustment must be made
When you change any accounting policy you:
Do NOT revise prior years’ financial stmts
Calculate the total change for all prior years and charge it directly to the Capital account
Record this year’s amortization using the new method.
Why would it be done this way?

26. C.C.A. Capital Cost Allowance
CCA is the government’s method of calculating amortization for tax purposes.
CCA is exactly like the Declining Balance method.
However, CCA only allows you to recognize ½ a year’s amortization in the year of disposal AND purchase.
CCA rates are specific, and are the maximum allowable rates for a year.

27. C.C.A. and Income Taxes Must report using GAAPs
Most firms use straight-line (it’s easy)
But taxes are determined using tax law (CCA).
This creates a discrepancy. Observe

28. Practice Questions
BE 9-1, 2, 4, 5, 6, 7, 8

29. Capital Expenditures During Useful Life
Expenditures on existing capital assets are classified as operating or capital
Ordinary repairs (operating expenditures):
Costs to maintain operating efficiency and productive life of the long-lived asset
Usually small amounts that occur frequently
Debited to Repairs Expense as incurred
Example: oil change, repainting a building, replacement of a worn-out gears

30. Capital Expenditures During Useful Life 2
Additions and improvements (capital expenditures):
Costs to increase the efficiency, capacity or useful life of the long-lived asset
Usually material in amount and occur infrequently
Debited to the long-lived asset affected
New amortization amount needs to be calculated

31. Revised Amortization Calculations
When a change is made:
No correction of previous amortization expense
Amortization expense for current and future years is revised
Remaining Amortizable Cost at Time of Change in Estimate
Net Book Value at Time of Change in Estimate -
Revised Residual Value =
Remaining Amortizable Cost at Time of Change in Estimate ÷
Remaining Estimated Useful Life =
Revised Annual Amortization Expense

32. Impairments
Long-lived assets are written down to market value when their value is permanently impaired
Impairment loss occurs when:
Decline in market value of asset is permanent, and
Net book value of asset is not recoverable
Amount of loss = net book value - market value
Entry to record impairment loss:

33. Disposals of Property, Plant and Equipment
Four steps required to record a disposal:
1. Update amortization
For the part of the year to the date of disposal
2. Calculate the net book value
= Cost - Accumulated Amortization
3. Calculate the gain or loss
= Proceeds – Net Book Value
Proceeds > net book value: gain
Proceeds < net book value: loss
4. Record the disposal

34. Disposals of Property, Plant and Equipment 2
Entry to record disposal of asset:
Retirement of Property, Plant and Equipment
No proceeds are received
Debit accumulated amortization for full amount of amortization and credit asset account for original cost
May be no difference if fully amortized; otherwise difference is a loss on retirement

35. Example
August 1, 2008 Baseyev Enterprises retires its printing equipment, which cost $31,200. At the time of purchase, on August 1, 2004, the printing equipment was expected to have a useful life of four years with no residual value. Baseyev used straight-line amortization and the annual amortization expense was $7,800 per year ($31,200/4) or 650 per month ($7,800/12). The balance in the account Accumulated Amortization at Baseyev’s year end, December 31, 2007, was $26,650.

36. Step 1 Updated Amortization
Amortization for the fraction of the year to the date of disposal must be recorded
Date
Particulars
Debit
Credit
Aug 1
Amortization Expense ,550
Accumulated Amortization (assumed) ,550
To record 7 months of depreciation on disposed asset.
(650*7)

37. Fully Amortized 2
Accumulated Amortization is $31,200 ($26,650 +4,550). The printing equipment is fully amortized with a net book value of 0.
Date
Particulars
Debit
Credit
Aug 1
Accumulated Amortization – Printing Equipment ,200
Printing Equipment ,200
To record retirement of fully amortized printing equipment

38. Not Fully Amortized
What if there was still Net book value of 4,550 left? And you got 0 money for the printing equipment? 2
Date
Particulars
Debit
Credit
Aug 1
Accumulated Amortization – Printing Equipment ,650
Loss on Disposal of ,550
Printing Equipment ,200
To record retirement of fully amortized printing equipment

39. Sale of Property, Plant and Equipment
Remove the value of all accounts associated with that asset, and record receipt of cash.
Date
Particulars
Debit
Credit
April 1
Cash ,000
Accumulated amortization – office furniture ,920
Office Furniture ,200
Gain on sale of equipment ,720
To record gain on the sale of buffing equipment.
Gain or loss equals = Selling Price – Book Value
$1,720 = ($ $13,280)
Historical Cost – Accumulated Amortization
($60,200 – $46,920) = $13,280

40. Exchange of Property, Plant and Equipment
Some long lived assets are sold for cash when they are no longer needed. Others are exchanged for new assets
Trade-in allowance: due to the value of the old traded assets, the purchase price of the new one is reduced by that value.
Monetary exchange and nonmonetary exchange of assets.

41. Monetary Exchange of Assets
Both an asset and money is given in exchange to purchase a new asset
Step 1: Update any unrecorded amortization expense to date of the exchange.
Step 2: Calculate net book value (cost –accumulated amortization)
Step 3: Calculate any gain or loss on disposal [fair market value – net book value = gain (loss)]

42. Monetary Exchange of Assets
Step 4: Record the exchange as follows
Remove the cost of the accumulated amortization of the asset that is given up
Record any gain or loss on disposal
Record the new asset at the fair market value of the old asset plus any cash paid (or received)
Record the cash paid or received

43. Example
Chilko Company exchanged old computers for new computers on October 1, The original cost of the old computers was $61,000 on January 1, Amortization is calculated using the straight-line method, over the three-years useful life, with an estimated residual value of $1,000. The fair market value of the old computers on October 1 is $5,000. The list price of the new computers was $51,000. Chilko received an $8000 trade-in allowance from the computer retailer for the old computers and paid $43,000 cash for the new computers.

44. Step 1: update the Amortization
$20,000 Annual Amortization Expense = [(61,000-1,000)/3] So amortization for nine months =$15,000 = [20,00*(9/12)]
Date
Particulars
Debit
Credit
Oct. 1
Amortization Expense
Accumulated Amortization – Computers ,000
To record amortization expense for the first 9 months of 2008

45. Step 2: Calculate the net book value
Accumulated Amortization on October 1, 2008: $55,000 = [20, ,000] 61,000 – 55,000 = 6,000

46. Step 3: Calculate any gain or loss
Fair market value – book value = gain (loss) 5,000 – 6,000 = (1,000)

47. Step 4: Record the Exchange
Date
Particulars
Debit
Credit
April 1
Computers (new) ,000
Accumulated amortization – computers ,000
Loss on Disposal ,000
Computers (new) ,000
Cash ,000
To record exchange of computers, plus cash .

48. Practice Questions
E9-6
E9-8
P9-6A
P9-7A

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

50. NATURAL RESOURCES Acquisition Cost
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.

51. NATURAL RESOURCES Amortization
The units-of-activity method is generally used to calculate amortization
Inventory $$$$
Accumulated Amortization $$$$
Disposal, just as with property, plant and equipment, any unrecorded amortization must be updated for the portion of the year up to the date of disposal…

52. ILLUSTRATION 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:

53. INTANGIBLE ASSETS Intangible assets cannot be touched.
They are rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.

54. TYPES OF INTANGIBLE ASSETS
Patents
Copyrights
Trademarks and Trade Names
Franchises and Licenses
Goodwill
Research and Development Costs

55. COPYRIGHTS
Copyrights are granted by the federal government giving the owner the exclusive right to reproduce and sell artistic or published work
Copyrights extend for the life of the creator plus 50 years

56. TRADE MARKS/NAMES
Word, phrase, jingle or symbol that distinguishes or identifies a particular enterprise or product
If indefinite life, do not amortize. Test for impairment

57. PATENTS
Exclusive right to manufacture, sell or control granted for 20 years
Legal costs of protecting a patent in an infringement suit are added to the Patent account and amortized over the remaining life of the patent

58. FRANCHISES
Contractual agreement under which the franchiser grants the franchisee the right
To sell certain products
To render specific services or to use certain trademarks or trade names, usually within a designated geographic area
Annual fees are not capitalized, but are expensed.

59. LICENSES
Operating rights permit the enterprise to use public property in performing its service (i.e. the use of airwaves for radio or TV broadcasting)
Annual fees are NOT capitalized, but expensed.

60. GOODWILL
Goodwill represents favourable attributes that relate to a business enterprise
Recorded only in an exchange transaction that involves the purchase of an entire business
Goodwill = (Price paid – Equity in Business)
Goodwill is not written off as it has an unlimited useful life. It must be tested regularly for impairment.
Impairment is when fair market value for an assets drops below the book value.

63. GOODWILL Two steps: Things to consider in determining FMV:
ONE: If FMV > Book Value = no impairment
TWO: If not, then Goodwill is impaired.
Things to consider in determining FMV:
Significant adverse change in legal or business climate
Adverse action by a regulator
Unanticipated competition
Loss of a key personnel
More-likely-than-not expectation that a significant portion of a reporting unit will be sold or disposed of
Impairment of a significant asset group within a reporting unit
Recognition of a goodwill impairment loss by a subsidiary

64. RESEARCH AND DEVELOPMENT COSTS
Research costs–record as an expense when incurred
Development costs–capitalize if associated with an identifiable, feasible product. Otherwise, expense
What does identifiable and feasible mean?

65. ACCOUNTING FOR INTANGIBLE ASSETS
In general, accounting for intangible assets is the same as for capital assets.
Intangible assets are:
Recorded at cost;
Written off over useful life in a rational and systematic manner;
At disposal, book value is eliminated and gain or loss, if any, is recorded.

66. AMORTIZATION Amortizable intangible assets:
Have defined lives
Allocate cost to expense over the shorter of
Useful (economic) life, or
Legal life
Straight-line method of amortization is used
Unamortizable Intangible assets:
Have indefinite useful lives,
Do not amortize, and
Must be tested for impairment (when fair market value for an assets drops below the net book value).

67. FINANCIAL STATEMENT PRESENTATION
Capital Assets are often combined on the Balance Sheet.
If so, there should be full disclosure in the notes to the financial statements, which means disclose:
Balances in each major asset class,
Accumulated amortization of each major class, (or of assets in total),
Amortization methods used should be described, and
Amount of amortization expense for the period disclosed as well.

69. Sales Total Assets Turnover
ASSET TURNOVER RATIO
The ratio that shows how efficiently a company uses its assets to generate sales is the asset turnover ratio.
Net Average Assets
Sales Total Assets Turnover  =

70. Income Total Assets Assets
RETURN ON ASSETS
The ratio that shows the profitability of assets used in the earnings process is the return on assets.
Net Average Return on
Income Total Assets Assets  =

71. Practice Questions
E9-12, 13, 14