1. FINANCIAL ACCOUNTING CHAPTER 8 Understanding LONG-TERM ASSETS
Canadian Edition
CHAPTER 8
LONG-TERM ASSETS
John Wiley & Sons Canada, Ltd. ©2015
Prepared by: Rosalie E. Harms, CMA

2. Learning Objectives
L01 – Identify and distinguish between various types of long-term assets.
L02 – Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized.
L03 – Explain why property, plant, and equipment assets are depreciated.
L04 – Identify the factors that influence the choice of depreciation method and implement the most common methods of
depreciation.
L05 – Describe and implement changes in depreciation estimates and methods.

3. Learning Objectives – cont.
L06 – Explain what it means if property, plant, and equipment assets are impaired.
L07 – Account for the disposal of property, plant, and equipment.
L08 – Explain the effect of depreciation on income taxes.
L09 – Explain the accounting treatment for intangible assets, including amortization.
L010 – Explain the accounting treatment for goodwill, including impairment.
L011 – Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results.

4. Various Types of Long Term Assets
There are three main categories of long term or capital assets:
Property, plant and equipment – these are tangible assets that have physical presence and includes land, buildings and machinery
Intangible assets – these are intangible assets without physical presences and includes trademarks, patents and copyrights
Goodwill – which arises when two businesses are combined
LO1

5. The Significance of Long Term Assets
Companies invest in long term assets to generate future revenues
The purchase and sale of long term assets are often the most significant investing activities of a company
An asset purchase represents a cash outflow
An asset sale represents a cash inflow
Most long term assets are subject to depreciation and amortization
L01

6. Investing Activities: Common Transactions
L01

7. Valuation of PP & E An asset represents future economic benefits:
Used to generate future revenue through sales of products or services
Cash received over several future periods
Under IFRS there are two valuation models
Cost Model – only model allowed under ASPE
Revaluation Model
L02

8. The Cost Model
Assets reflected at their carrying amount on the statement of financial position
Expensed (depreciated) over the useful life
Carrying Amount
Original cost less accumulated amortization and accumulated impairment losses
This does not represent what the asset is worth
Accumulated depreciation is a contra-asset account
L02

9. Carrying Amount
L02

10. What is included in “Cost”?
Costs to be capitalized include:
Purchase price less an rebates or discounts
Non refundable taxes and import duties on the purchase price
Legal costs associated with the purchase
Shipping or transportation costs
Site preparation, installation and set up costs
L02

11. Purchase Price Allocation

12. Subsequent Costs
Costs incurred after an assets purchase will be treated in one of two ways:
Capitalized – or added to the cost of the asset
Expensed – treated as a period cost
L02

13. Depreciation
If costs are capitalized they will be expensed in future periods through the depreciation process
In order to depreciate PP&E must know the following:
Estimated residual value
Estimated useful life
Depreciable amount
Depreciable amount = Cost – Estimated Residual Value
L03

14. Depreciation Methods
The three most common deprecation methods include:
Straight line depreciation method – the simplest and most commonly used method
Units-of-production (units-of-activity) method
Diminishing-balance (declining-balance) method
L04

15. Comparison of Depreciation Methods
L04

16. Depreciation Calculations
Data: January 1, 2016 company buys equipment for $50,000. Estimated useful life is 5 years and estimated residual value is $5,000. The company has a December 31, year end.
L04

17. Original Cost - Estimated Residual Value
Straight-Line Method
Original Cost - Estimated Residual Value
Depreciation Expense =
Estimated Useful Life
$50,000 - $5,000 =
L04
5 years =
$9,000 per year

18. Straight-Line Method Depreciation Schedule Year Beg. Book Value
Depreciation Expense
Ending Book Value 1
$50,000
$9,000
$41,000 2
41,000
9,000
32,000 3
23,000 4
14,000 5
5,000
$45,000
L04

19. Straight-Line Method
Allocates the cost evenly over the life of the asset
Estimates needed for:
Useful life
Residual value
Advantage is simplicity
L04

20. Units of Production Method
Data/Assumptions:
Original cost $50,000
Estimated
Residual value $5,000
Usage:
Year 1
4,000 units
Year 2
5,000 units
Year 3
6,000 units
Year 4
4,500 units
Year 5
3,000 units
22,500 units
L04

21. Units of Production Method
Depreciation Expense per Unit
Cost - Residual Value =
Estimated Total Units of Output
$50,000 - $5,000 =
L04
22,500 units =
$2.00 per unit

22. Units of Production Method
Depreciation Schedule
Year
Cost per Unit
Units Produced
Depreciation Expense
Ending NBV 1
$2.00
$4,000
$8,000
$42,000 2
2.00
5,000
10,000
32,000 3
6,000
12,000
20,000 4
4,500
9,000
11,000 5
3,000
$45,000
L04

23. Units of Production Method
Assumptions
Benefits derived are related to the output or use of an asset
Requires that the useful life can be expressed as units of output
L04

24. Accelerated Depreciation Methods
Multiply the carrying value of the asset by a fixed percentage
Carrying value decreases each year
Depreciation expense decreases each year
L04

25. Accelerated Depreciation Methods
Percentage rates
Lower when asset has longer life
Double-diminishing-balance method
Percentage is double the straight-line rate
Residual value
Not used for calculations
Serves as a constraint
Formula
Carrying value X Depreciation Rate = Depreciation Expense
L04

26. Double Diminishing Balance Method
Data:
Original cost $50,000
Estimated Residual value $5,000
Estimated Useful life years
Rate Calculation:
DDB rate = DB% x SL rate = 2 x 1/n yrs
= 2 x 1/5yrs
= 40%
L04

27. Double-Diminishing- Balance Method
Depreciation Schedule
Year
Beginning NBV
Depreciation Expense
Ending NBV 1
$50,000
$20,000
$30,000 2
30,000
12,000
18,000 3
7,200
10,800 4
4,320
6,480 5
1,480
5,000
L04

28. Recording Depreciation Expense
The same journal entry is used for all depreciation methods:
Depreciation expense (SE) XX
Accumulated depreciation (XA) XX
Use of a contra-asset account—more informative than reducing the asset directly.
Depreciation is a non cash expense – it does not involve cash
L04

29. Changes in Depreciation Methods
Companies are required to annually review estimated residual values, estimated useful lives and depreciation methods used.
Changes are done prospectively and not retrospectively
L05

30. Changes in Depreciation Estimates
Estimates of useful life and residual value may change over time - depreciation may change as a result.
Example: Data/assumptions
Original cost $50,000
Estimated
Residual value $5,000
Useful life years
Straight-line depreciation $9,000
Carrying Value at end of year 3 $23,000
L05

31. Changes in Estimates – Useful Life31
Change in year 4
Residual value $2,000
Remaining useful life years
Remaining Book Value – Residual Value
Depreciation Expense =
Useful Life
L05
$23,000 – $2,000 =
4 years
$5,250 per year for years
4, 5, 6 and 7 =

32. Impairment
When indications of impairment are present, management then determines:
The total of all the future cash flows that are expected to be generated from the assets use
and
The asset’s fair value less any selling costs
The greater of these two is the Recoverable Amount.
Impairment Loss is the excess of the recoverable amount over the asset carrying value.
L06

33. Calculation of Impairment Loss

34. Impairment Loss Example
At the end of 2017 the carrying amount of an asset is $23,000. Management determines that as a result of damage to the equipment the recoverable from its future use is only $20,000.
The following entry would be made to record the impairment loss:
Dr. Loss on Impairment $3,000
Cr. Accumulated Impairment Losses, Equip. $3,000
L06

35. Asset Disposals
When PP&E is disposed of or scrapped it is derecognized. There are two steps necessary whenever this occurs:
The asset is depreciated up to the date of recognition
The asset and related accumulated depreciation account should be removed from the books and any resulting gain or loss should be determined.
L07

36. Gains / Losses on Asset Disposal

37. Sale of Capital Assets
Original cost and accumulated depreciation removed from accounts
Gain or loss: difference between cash received and book value of asset
Cash (A) ,000
Accumulated depreciation (XA) ,000
Equipment (A) ,000
Gain on sale of equipment (SE) ,000
L07

38. Disposal of Capital Assets
If assets are disposed of and no cash is received:
Accumulated depreciation (XA) 45,000
Loss on disposal of equipment (SE) 5,000
Equipment (A) 50,000
L07

39. Corporate Income Taxes
Canada Revenue Agency (CRA)
Depreciation expense is allowed to be deducted to calculate accounting income
Capital cost allowance (CCA) instead must be used to calculate taxable income
L08

40. Corporate Income Taxes
There are a few important differences between depreciation and CCA:
The Income tax act determine the method of depreciation that must be used, it is similar to the diminishing-balance- method
The tax act also specifies the CCA Rate that must be used
Residual values are ignored
The tax act determines the maximum depreciation that a company may claim on its income tax return
L08

41. Revaluation Model
Under this model, PP&E assets are carried at fair value less any subsequent accumulated depreciation and subsequent impairment losses
Revaluation dates may be annual or every three or four years
If a company is using this model for a class of assets, then all assets must be revalued
L08

42. Intangible Assets
Intangible assets have probable future value but may not have physical form
Guidelines:
If developed internally, expense costs as incurred
If purchased, acquisition costs can be capitalized
L09

43. Intangible Assets Patents, Trademarks, Copyrights
Legal life is the maximum for amortizing
Useful, or economic life, is generally used for calculating amortization
Trade Secrets – no legal registration system in Canada
Licences, Customer Lists, Franchise Rights
Computer Software – includes web development costs provided site is used to generate revenues
Development Costs – can be capitalized provided specific criteria are met. Research costs can NOT be capitalized
L09

44. Intangible Assets cont.
Initially recorded at costs, IFRS allows for either the cost model or revaluation model to be used
Management must determine whether or not he asset has an indefinite useful life or a finite useful life
Often the legal life exceeds an assets useful life
L09

45. Intangible Assets - Amortization
Estimate useful life and residual value (if any)
Straight-line method is most commonly used
Accumulated amortization account rarely used
Amortization expense (SE) XX
Patents (A) XX
L09

46. Goodwill
Goodwill is a long term assets that arises when two businesses are combined
It is only recognized when it has been purchased as part of a business combination
Internally generated goodwill can not be recognized
L10

47. Determining Goodwill
L10

48. Determining the Carrying Amount of Goodwill
Goodwill is carried on the statement of financial position at cost less any accumulated impairment losses
L10

49. Treatment of Goodwill Goodwill is not amortized
Must be reviewed annually to determine whether there is evidence that it has been impaired
L10

50. Financial Statement Analysis50
Measuring the age of assets:
Average Age % = Total Accumulated Depreciation
Total PP&E minus Land
Average Age = Total Accumulated Deprecation
Depreciation Expense
Effective company use of its long term assets:
Fixed Asset Turnover = Sales Revenue
Average Net PP&E
L11 50

51. Copyright
Copyright © 2015 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.