Chapter 9: Reporting and Interpreting Property ... amazonaws com
LECTURE 8
COMM 2AA3
Chapter 9: Reporting and Interpreting Property, Plant and Equipment; Natural Resources; and Intangibles October 28, 2013 Long-Lived Assets Assets that are actively used in operations to generate future benefits beyond one year Can be classified into tangible and intangible assets Tangible Assets Resources that have physical substance (a definite size and shape); used in the operations of a business and not intended for sale to customers Also called “Chattel” Also called – property, plant and equipment; fixed assets; capital assets; operational assets Includes – land, amortizable assets (building, equipment etc) and natural resources (mineral deposits, timber) o Land – eg/ mining but doesn’t typically depreciate Except for land, all tangible assets are subject to depreciation or depletion (natural resources) Other Long-Lived Assets o Constructed assets o Leased assets o Asset Retirement Obligations Measurement – tangible assets are measured at acquisition cost; cost includes the cash equivalent purchase price plus all reasonable and necessary expenditures made to acquire and prepare the asset for its intended use (can differentiate expense from cost) o Acquisition is amount paid to acquire good; part of historical cost (which includes costs to prepare goods) o Expense – when object is operational o Acquisition Cost – Buildings Purchase price Architectural fees Renovation and repair costs and cost of permits (before move-in; if already operational then renovation – expense) Legal and realty fees Title fees Excavation and construction costs o Acquisition Cost – Equipment Purchase price – including taxes Installation costs Modification to building necessary to install equipment – eg/ supply power, build new room for equipment Transportation costs o Acquisition Cost – Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not amortizable o Acquisition for non-cash consideration – record at current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident Purchase item for $100; cash $20, N/P $80 clear value of item is $100 Purchase item for $100; cash $20, issue 80 shares at a face price of $1, but a market value of $2 unclear value of equipment purchases Face price – when company gives shares, amount company sells shares for Market price – market know prices will go up, amount buyers willing to pay for shares o Other Long Lived Assets Constructed assets – creation of new asset, no fine timeline Leased assets – operational lease (I/S as an expense), capital lease (balance sheet as an asset); IFRS has 4 rules to determine whether it is an asset or expense Asset Retirement Obligations – eg/ mining, lead and harmful chemicals left; pay to restore land – ridding of asset, there is an obligation; have to record this cost when recording the asset (before cost even is incurred – will be a gain or loss afterward to account for difference between estimate and reality) 1
LECTURE 8
COMM 2AA3
Acquisition as a Basket Purchase – the total cost of a combined purchase of land and building is separated on the basis of their relative market values Two methods to determine value recorded for each item – Relative Appraised Value and Residual Value One tangible, one intangible Eg/ TV and warranty Eg/ Buy a house, get the land with it; eg/ buy TV, get Blu-ray player Eg/ On Jan 1, WestJet purchased land and building for $300,000 cash; the appraised values are building, $189,000 and land $126,000. How much of the $300,000 purchase price will be charged to the building and land accounts 189 + 126 = 315 Appraisals are subjective Method 1 – Relative Appraised Value o Building = 189,000/315,000 x 300,000 o Land = 126,000/315,000 x 300,000 Eg/ For a TV and Blu-ray as a deal for $200. The TV separately costs $170 and Blu-ray separately costs $70. How much of the $200 that you paid is assigned to the TV and Blu-ray? Method 2 – Residual Value o Cannot argue that the value of this purchase is in the TV o TV = $170 o Blu-Ray = $200 - $170 = $30 (residual) Subsequent Costs (after asset has been readied for intended use)– two types of expenditures; can be used if increases productive life or capacity o Capital Expenditures – increase the productive life (useful life), operating efficiency or capacity of the asset (B/S) o Revenue Expenditures – maintain the productive capacity; operating expense (I/S) Repairs, Maintenance and Betterments o Revenue expenditure – goes into I/S, operating expense o Capital – B/S o
Capital and Revenue Expenditures o Capital Expenditure – eventually comes into I/S as depreciation; income higher initially o Revenue Expenditure – directly into I/S as an expense
Many companies have policies expensing all expenditures below a certain amount according to the materiality constraint Depreciation o Non-cash flow item o Allocating to expense the cost of an asset over its useful life in a rational and systematic manner, in accordance with the matching principle o Process of cost allocation, not asset valuation Taking cost from balance sheet into income statement over its useful life (over time, not instantaneously) – process of cost allocation from B/S to I/S Value of asset decreases o Not a cash fund o Depreciation Methods Straight-line Declining-balance o
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LECTURE 8
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COMM 2AA3
Sum-of-years- digits Units-of-activity Factors in Calculating Depreciation Cost – original purchase price Useful life – original life that asset is expected to last; can change Salvage Value – amount expected to be received after useful life Terminal salvage value (TSV) – at the end of its life used in this course Current salvage value (CSV) – currently Depreciable Cost = Cost – Salvage Value Straight Line Method – depreciation is constant for each year of the assets useful life Annual Depreciation = Depreciable Cost/Useful Life =1/UL x (C-SV) = Straight line depreciation rate x (Amortizable or depreciable cost) Declining Balance Method – accelerated depreciation method; result in more depreciation in early years and less in later years Annual Depreciation = Beginning book value x depreciation rate Rate = 1/UL applied to book value Rate = 1.5 / UL = 150% declining balance method Rate = 2/UL = Double declining balance method Difference from straight line method – applying rate to book value, not amortizable cost Sum-of-the-years-digits – accelerated depreciation method Annual depreciation in first year = Depreciable cost x (n/SYD) n = useful life in year SYD = [n * (n+1)]/2 n in numerator decreases by one for each subsequent year Units of Activity o Useful life is expressed in terms of the estimated total units of production or use expected from the asset o Eg/ Calculate the annual depreciation expense for the following asset: Cost $100,000 Useful Life 5 Years Salvage Value $20,000 Estimated Total Output 1,000,000 units Annual Output
Summary of Results
Comparison – Income Statement o The declining-balance and SYD methods result in Higher depreciation expense in the early years, compared to straight-line Lower earnings in the early years and higher earnings in the later years, compared to the straight line method Changes in Estimates – changes in the assumptions about the assets useful life and the salvage value o When a change in an estimate is required, the change is made in current and future years but not to prior periods o Revised depreciation is calculated using the net book value at the time of the change in estimates o Eg/ On Jan 1, 2001, ABC purchased a truck for $40,000 with an estimated useful life of 6 years and salvage value of $10,000; On Dec 15, 2004, ABC revised its estimate of useful life to 8 years and of salvage value to $5,000; calculate the depreciation expense for 2004 assuming ABC uses straight line method to amortize the truck Asset Impairment o Impairment is the loss of a significant portion of the utility of an asset through Casualty Obsolescence 3
LECTURE 8
COMM 2AA3
Lack of demand for the assets services o A loss should be recognized when an asset suffers a permanent impairment o Impairment loss = net book value – fair value Disposal of PP&E o Four steps must be followed to record the disposal of PPE 1. Update the depreciation 2. Calculate the net book value 3. Calculate the gain or loss 4. Record the disposal o Eg/ XYZ Inc. sold the following two machines in 2005: Both assets are amortized using the straight line method
Natural Resources o Extracted from the natural environment o A noncurrent asset presented at cost less accumulated depletion o Eg/ oil, coal, gold o Total cost of asset = cost of acquisition + exploration + development o Total cost is allocated over periods benefitted by means of depletion o Depletion is like depreciation o Depletion of Natural Resources - depletion calculated using units-of-production method (Acquisition and development cost – residual value) / estimated recoverable units
Intangible Assets Involve rights, privileged and competitive advantages that result from ownership of long-lived assets that do not possess physical substance Includes – patents, copyrights, trademarks, franchises, goodwill, technology, licensing rights, leaseholds o Patents – can depreciate o Trademarks – typically do not depreciate o Goodwill – cannot be measured; not typically on balance sheet; arises when company is sold The amount that a company will pay, over net assets = goodwill amount paid that is greater than net assets Net Assets (eg/ 200) = assets (eg/ 500) minus liabilities (eg/300) Some intangibles are subject to amortization Noncurrent assets without physical substance Useful life is often difficult to determine Often provide exclusive rights or privileges Usually acquired for operational use Record at current cash equivalent cost, including purchase price, legal feels and filing fees Definite Life – amortize over shorter of economic life or legal life, subject to rules specified by GAAP; use straight-line method Indefinite Life – not amortized; tested at least annually for possible impairment and book value is reduced to fair value if impaired Amortization of intangible is a cost allocation process similar to amortization of tangible assets and depletion of natural resources Goodwill – occurs when one company buys another company; only purchased goodwill is an intangible asset; the amount by which the purchase price exceeds the fair market value of net identifiable asset acquired o Eg/ Arpec Company paid $2,000,000 to purchase all of Utek Company’s assets and assumed liabilities of $400,000; the acquired assets were appraised at a fair value of $1,800,000 Goodwill = $600,000
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LECTURE 8
COMM 2AA3
Trademarks – a symbol, design, or logo associated with a business; internally developed trademarks have no recorded asset cost; purchased trademarks are recorded at cost Patents – exclusive rights granted by federal government to sell of manufacture an invention o Cost = purchase price + legal cost to defend o Amortize cost over the shorter of useful life of 20 years o Research and development costs that might result in a patent are normally expensed as incurred Copyrights – exclusive rights granted by the federal government to protect artistic or intellectual properties o Legal life = life of creator + 50 years o Amortize cost over the period benefits Franchises – legally protected right to sell products or provide services purchased by franchisee from franchisor o Purchase price is an intangible asset that is amortized Licensing Rights – limited permission to use a product or service according to specific terms and conditions o You may be using computer software that is made available to you through a campus licensing agreement Technology – a category of intangible assets that includes a company’s website and any computer programs written by its employees
Not Intangible Asset Research and Development Expenses o If an intangible asset is developed internally, the cost of development normally is recorded as research and development expense o Under specific circumstances, development costs can be deferred to future accounting periods, recorded as assets, and then amortized over time, if the company can meet specific criteria for deferral
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COMM 2AA3
Chapter 9: Reporting and Interpreting Property, Plant and Equipment; Natural Resources; and Intangibles October 28, 2013 Long-Lived Assets Assets that are actively used in operations to generate future benefits beyond one year Can be classified into tangible and intangible assets Tangible Assets Resources that have physical substance (a definite size and shape); used in the operations of a business and not intended for sale to customers Also called “Chattel” Also called – property, plant and equipment; fixed assets; capital assets; operational assets Includes – land, amortizable assets (building, equipment etc) and natural resources (mineral deposits, timber) o Land – eg/ mining but doesn’t typically depreciate Except for land, all tangible assets are subject to depreciation or depletion (natural resources) Other Long-Lived Assets o Constructed assets o Leased assets o Asset Retirement Obligations Measurement – tangible assets are measured at acquisition cost; cost includes the cash equivalent purchase price plus all reasonable and necessary expenditures made to acquire and prepare the asset for its intended use (can differentiate expense from cost) o Acquisition is amount paid to acquire good; part of historical cost (which includes costs to prepare goods) o Expense – when object is operational o Acquisition Cost – Buildings Purchase price Architectural fees Renovation and repair costs and cost of permits (before move-in; if already operational then renovation – expense) Legal and realty fees Title fees Excavation and construction costs o Acquisition Cost – Equipment Purchase price – including taxes Installation costs Modification to building necessary to install equipment – eg/ supply power, build new room for equipment Transportation costs o Acquisition Cost – Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not amortizable o Acquisition for non-cash consideration – record at current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident Purchase item for $100; cash $20, N/P $80 clear value of item is $100 Purchase item for $100; cash $20, issue 80 shares at a face price of $1, but a market value of $2 unclear value of equipment purchases Face price – when company gives shares, amount company sells shares for Market price – market know prices will go up, amount buyers willing to pay for shares o Other Long Lived Assets Constructed assets – creation of new asset, no fine timeline Leased assets – operational lease (I/S as an expense), capital lease (balance sheet as an asset); IFRS has 4 rules to determine whether it is an asset or expense Asset Retirement Obligations – eg/ mining, lead and harmful chemicals left; pay to restore land – ridding of asset, there is an obligation; have to record this cost when recording the asset (before cost even is incurred – will be a gain or loss afterward to account for difference between estimate and reality) 1
LECTURE 8
COMM 2AA3
Acquisition as a Basket Purchase – the total cost of a combined purchase of land and building is separated on the basis of their relative market values Two methods to determine value recorded for each item – Relative Appraised Value and Residual Value One tangible, one intangible Eg/ TV and warranty Eg/ Buy a house, get the land with it; eg/ buy TV, get Blu-ray player Eg/ On Jan 1, WestJet purchased land and building for $300,000 cash; the appraised values are building, $189,000 and land $126,000. How much of the $300,000 purchase price will be charged to the building and land accounts 189 + 126 = 315 Appraisals are subjective Method 1 – Relative Appraised Value o Building = 189,000/315,000 x 300,000 o Land = 126,000/315,000 x 300,000 Eg/ For a TV and Blu-ray as a deal for $200. The TV separately costs $170 and Blu-ray separately costs $70. How much of the $200 that you paid is assigned to the TV and Blu-ray? Method 2 – Residual Value o Cannot argue that the value of this purchase is in the TV o TV = $170 o Blu-Ray = $200 - $170 = $30 (residual) Subsequent Costs (after asset has been readied for intended use)– two types of expenditures; can be used if increases productive life or capacity o Capital Expenditures – increase the productive life (useful life), operating efficiency or capacity of the asset (B/S) o Revenue Expenditures – maintain the productive capacity; operating expense (I/S) Repairs, Maintenance and Betterments o Revenue expenditure – goes into I/S, operating expense o Capital – B/S o
Capital and Revenue Expenditures o Capital Expenditure – eventually comes into I/S as depreciation; income higher initially o Revenue Expenditure – directly into I/S as an expense
Many companies have policies expensing all expenditures below a certain amount according to the materiality constraint Depreciation o Non-cash flow item o Allocating to expense the cost of an asset over its useful life in a rational and systematic manner, in accordance with the matching principle o Process of cost allocation, not asset valuation Taking cost from balance sheet into income statement over its useful life (over time, not instantaneously) – process of cost allocation from B/S to I/S Value of asset decreases o Not a cash fund o Depreciation Methods Straight-line Declining-balance o
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LECTURE 8
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COMM 2AA3
Sum-of-years- digits Units-of-activity Factors in Calculating Depreciation Cost – original purchase price Useful life – original life that asset is expected to last; can change Salvage Value – amount expected to be received after useful life Terminal salvage value (TSV) – at the end of its life used in this course Current salvage value (CSV) – currently Depreciable Cost = Cost – Salvage Value Straight Line Method – depreciation is constant for each year of the assets useful life Annual Depreciation = Depreciable Cost/Useful Life =1/UL x (C-SV) = Straight line depreciation rate x (Amortizable or depreciable cost) Declining Balance Method – accelerated depreciation method; result in more depreciation in early years and less in later years Annual Depreciation = Beginning book value x depreciation rate Rate = 1/UL applied to book value Rate = 1.5 / UL = 150% declining balance method Rate = 2/UL = Double declining balance method Difference from straight line method – applying rate to book value, not amortizable cost Sum-of-the-years-digits – accelerated depreciation method Annual depreciation in first year = Depreciable cost x (n/SYD) n = useful life in year SYD = [n * (n+1)]/2 n in numerator decreases by one for each subsequent year Units of Activity o Useful life is expressed in terms of the estimated total units of production or use expected from the asset o Eg/ Calculate the annual depreciation expense for the following asset: Cost $100,000 Useful Life 5 Years Salvage Value $20,000 Estimated Total Output 1,000,000 units Annual Output
Summary of Results
Comparison – Income Statement o The declining-balance and SYD methods result in Higher depreciation expense in the early years, compared to straight-line Lower earnings in the early years and higher earnings in the later years, compared to the straight line method Changes in Estimates – changes in the assumptions about the assets useful life and the salvage value o When a change in an estimate is required, the change is made in current and future years but not to prior periods o Revised depreciation is calculated using the net book value at the time of the change in estimates o Eg/ On Jan 1, 2001, ABC purchased a truck for $40,000 with an estimated useful life of 6 years and salvage value of $10,000; On Dec 15, 2004, ABC revised its estimate of useful life to 8 years and of salvage value to $5,000; calculate the depreciation expense for 2004 assuming ABC uses straight line method to amortize the truck Asset Impairment o Impairment is the loss of a significant portion of the utility of an asset through Casualty Obsolescence 3
LECTURE 8
COMM 2AA3
Lack of demand for the assets services o A loss should be recognized when an asset suffers a permanent impairment o Impairment loss = net book value – fair value Disposal of PP&E o Four steps must be followed to record the disposal of PPE 1. Update the depreciation 2. Calculate the net book value 3. Calculate the gain or loss 4. Record the disposal o Eg/ XYZ Inc. sold the following two machines in 2005: Both assets are amortized using the straight line method
Natural Resources o Extracted from the natural environment o A noncurrent asset presented at cost less accumulated depletion o Eg/ oil, coal, gold o Total cost of asset = cost of acquisition + exploration + development o Total cost is allocated over periods benefitted by means of depletion o Depletion is like depreciation o Depletion of Natural Resources - depletion calculated using units-of-production method (Acquisition and development cost – residual value) / estimated recoverable units
Intangible Assets Involve rights, privileged and competitive advantages that result from ownership of long-lived assets that do not possess physical substance Includes – patents, copyrights, trademarks, franchises, goodwill, technology, licensing rights, leaseholds o Patents – can depreciate o Trademarks – typically do not depreciate o Goodwill – cannot be measured; not typically on balance sheet; arises when company is sold The amount that a company will pay, over net assets = goodwill amount paid that is greater than net assets Net Assets (eg/ 200) = assets (eg/ 500) minus liabilities (eg/300) Some intangibles are subject to amortization Noncurrent assets without physical substance Useful life is often difficult to determine Often provide exclusive rights or privileges Usually acquired for operational use Record at current cash equivalent cost, including purchase price, legal feels and filing fees Definite Life – amortize over shorter of economic life or legal life, subject to rules specified by GAAP; use straight-line method Indefinite Life – not amortized; tested at least annually for possible impairment and book value is reduced to fair value if impaired Amortization of intangible is a cost allocation process similar to amortization of tangible assets and depletion of natural resources Goodwill – occurs when one company buys another company; only purchased goodwill is an intangible asset; the amount by which the purchase price exceeds the fair market value of net identifiable asset acquired o Eg/ Arpec Company paid $2,000,000 to purchase all of Utek Company’s assets and assumed liabilities of $400,000; the acquired assets were appraised at a fair value of $1,800,000 Goodwill = $600,000
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LECTURE 8
COMM 2AA3
Trademarks – a symbol, design, or logo associated with a business; internally developed trademarks have no recorded asset cost; purchased trademarks are recorded at cost Patents – exclusive rights granted by federal government to sell of manufacture an invention o Cost = purchase price + legal cost to defend o Amortize cost over the shorter of useful life of 20 years o Research and development costs that might result in a patent are normally expensed as incurred Copyrights – exclusive rights granted by the federal government to protect artistic or intellectual properties o Legal life = life of creator + 50 years o Amortize cost over the period benefits Franchises – legally protected right to sell products or provide services purchased by franchisee from franchisor o Purchase price is an intangible asset that is amortized Licensing Rights – limited permission to use a product or service according to specific terms and conditions o You may be using computer software that is made available to you through a campus licensing agreement Technology – a category of intangible assets that includes a company’s website and any computer programs written by its employees
Not Intangible Asset Research and Development Expenses o If an intangible asset is developed internally, the cost of development normally is recorded as research and development expense o Under specific circumstances, development costs can be deferred to future accounting periods, recorded as assets, and then amortized over time, if the company can meet specific criteria for deferral
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