Financial Accounting:: Tools For Business Decision-Making

Financial Accounting:1
Tools for Business DecisionMaking Fifth Canadian Edition
Prepared By: Debbie Musil Kwantlen Polytechnic University
Copyright John Wiley & Sons Canada, Ltd.
CHAPTER
9
1. 2.
C H APT ER
Reporting and 1 Analyzing Long-Lived Assets

Study Objectives
Determine the cost of property, plant and equipment. Explain and calculate depreciation.
3.
4. 5.
Describe other accounting issues related to depreciation.

Account for the disposal of property, plant and equipment. Identify the basic accounting issues for intangible assets and goodwill.
6.
7.
2
Illustrate how long-lived assets are reported in the financial statements.

Describe the methods for evaluating the use of assets.
CHAPTER
Property, Plant, and Equipment

1
Long-lived resources that:
Are controlled by the company
Have physical substance Are used in the operation of a business
Are not intended for sale to customers
Provide benefits over many years
CHAPTER
Determining the Cost of Property, Plant and Equipment 1

Record at cost, which includes:
Purchase price, including taxes and duties, less discounts or rebates
Expenditures necessary to bring asset to its intended location and make it ready for its intended use
CHAPTER
Types of Expenditures
1
Operating expenditures
Benefit only the current period
Immediately charged against revenue as an expense
Capital expenditures
Capitalized as an asset Benefit future periods
Increases a companys investment in productive activity
CHAPTER
Land
1
Cost of land includes
Purchase price
Closing costs such as title and legal fees Additional costs to prepare land for its intended use (less any proceeds from salvage)
Land has an unlimited life, therefore it is not depreciated
CHAPTER
Land Improvements
1
The costs of structural additions made to land (e.g. paving, fencing) These decline in service potential over time
They are recorded separately from land
Depreciated over their useful lives
CHAPTER
Buildings
1
All expenditures related to the purchase or construction of a building When a building is purchased such costs include:
Purchase price
Closing costs (legal fees, title, insurance) Costs required to make building ready for its intended use
CHAPTER
Buildings (Continued)
1
When a building is constructed, its cost consists of:
Contract price Architect's fees
Building permits
Excavation cost Interest costs during construction
CHAPTER
Equipment
1
Costs include:
Purchase price
Freight charges and insurance during transit paid by the purchaser
Assembling
Installing and testing
10
CHAPTER
Asset Retirement Costs

1
Cost of any obligation to dismantle, remove or restore a long-lived asset when it is retired These costs are estimated in advance and included as part of the cost of the asset
11
CHAPTER
Discussion Question
1
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?
12
CHAPTER
Buy or Lease?
Advantages of leasing
Reduced risk of obsolescence 100% financing Income tax
Off-balance sheet financing
Terminology
Lessor owner of asset for lease (e.g., landlord) Lessee company leasing asset from owner (e.g., tenant)
13
CHAPTER
Buy or Lease? (Continued)

1
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)
14
CHAPTER
Depreciation
1
Systematic allocation of the cost of property, plant and equipment over the assets useful life A process of cost allocation, not asset valuation Does not use or provide cash to replace the asset
15
CHAPTER
Factors In Calculating Depreciation

Illustration 9-2
16
CHAPTER
Depreciation Methods
1
Straight-line
Used by the majority of Canadian publiclytraded companies
Diminishing-balance
Units-of-production
17
CHAPTER
Example Depreciation Methods

1
A delivery van was bought on Jan. 1, 2012 Cost $33,000 Estimated residual value $3,000 Estimated useful life (in years) 5 Estimated useful life (in kilometres) 100,000
18
CHAPTER
Straight-Line Method
Illustration 9-3 Depreciation is constant for each year of the asset's useful life
19
CHAPTER
Diminishing-Balance Method
1
Produces a decreasing annual depreciation expense over an assets useful life
Depreciation is calculated based on the assets carrying amount, which diminishes each year as accumulated depreciation increases
Annual depreciation expense is calculated by multiplying the carrying amount by the depreciation rate
Residual value is not included in the calculation
Can be applied using different rates

Depreciation rate = Straight-line rate x multiplier
20
CHAPTER
Diminishing-Balance Method (Continued)

Illustration 9-5
21
CHAPTER
Units-of-Production Method
1
Useful life is expressed in terms of total units of production or activity expected from the asset
Such as units produced or machine-hours worked
Useful for factory machinery, vehicles, airplanes
22
CHAPTER
Units-of-Production Method
23
CHAPTER
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?
24
CHAPTER
Other Depreciation Issues

Significant components
May be depreciated separately
Income tax Impairments

When carrying amount of asset exceeds its recoverable amount
Cost vs. revaluation model

Revaluation model allowed under IFRS
Allows revaluation to fair market value
25
CHAPTER
Revising Periodic Depreciation

Revisions needed if:
Capital expenditures during useful life Impairment losses Change in estimated useful life or residual value Change in the pattern in which the assets economic benefits are consumed
Accounted for as a change in estimate

Change made in current and future years, but not to prior periods (prospectively)
26
CHAPTER
1. Update depreciation
Disposals of Property, Plant, and Equipment 1

Depreciation for the fraction of the year to the date of disposal must be recorded
2. Calculate carrying amount

Carrying amount = Cost Accumulated depreciation
3. Calculate gain or loss

Proceeds carrying amount = gain (loss)
Proceeds > carrying amount = Gain (Cr.) Proceeds < carrying amount = Loss (Dr.)
27
CHAPTER
Disposals of Property, Plant, and Equipment 1

4. Record disposal
Remove cost of asset and accumulated depreciation. Record proceeds (if any) and gain or loss on disposition (if any)
Cash Accumulated Depreciation Asset Gain on Disposal xxx xxx
xxx xxx
28
CHAPTER
Intangible Assets and Goodwill

1
Do not have physical substance
Rights, privileges and/or competitive advantages

For example, intellectual property in a production process
Must be identifiable either:

Can be separated from company and sold; or
Based on contractual or legal rights
29
CHAPTER
Accounting for Intangible Assets

1
Accounting for intangible assets parallels accounting for tangible assets
Recorded at cost including all costs to make asset ready for use
If intangible asset has a finite (limited) life, its cost must be systematically allocated over its useful life
For intangible assets, this is referred to as amortization rather than depreciation
Intangible assets with an indefinite (unlimited) life are not amortized

30
CHAPTER
Amortization for Intangibles

1
Amortize over shorter of
Estimated useful life
Legal life
Test for impairment
31
CHAPTER
Intangibles with Finite Lives

1
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
Copyrights
Protection for the life of the creator + 50 years
32
CHAPTER
Intangibles with Indefinite Lives

1
Trademarks and trade names
Word, jingle, symbol that distinguishes business
Franchises
Contractual agreement to sell products or services
Licences
Operating rights
33
CHAPTER
Goodwill
1
Asset representing future economic benefits arising from the purchase of a business
Excess of cost over fair market value of net assets (assets less liabilities) acquired Represents the extra value relating to a business when it is purchased Only identified with the business as a whole
Not amortized, but subject to an annual test for impairment

34
CHAPTER
Presentation of Long-Lived Assets 1

Statement of Financial Position
Reported as
Property, Plant and Equipment Intangible Assets Goodwill
Disclose cost and accumulated depreciation (amortization) of each major class of assets
Either in statement or in notes
IFRS also requires additional disclosures

35
CHAPTER
Presentation of Long-Lived Assets 1

Income Statement
Depreciation expense, gains and losses on disposal and impairment losses are included in the operating section
Statement of Cash Flows

Cash flows from the purchase and sale of longlived assets are reported in the investing section
36
CHAPTER
Return on Assets
1
Measures overall profitability
Profit . Return on Assets = Average Total Assets
Higher is better
37
CHAPTER
Asset Turnover
1
Measures how efficiently a company uses its assets
Asset Turnover =
Net Sales Average Total Assets
Higher is better
38
CHAPTER
Profit Margin Revisited

1
Together, profit margin and asset turnover explain the return on assets ratio:
Profit x Asset Margin Turnover
Return on Assets
39
CHAPTER
Comparing IFRS and ASPE
40
CHAPTER
Comparing IFRS and ASPE (Continued)
41
CHAPTER
Copyright Notice
Copyright 2012 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. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or 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.
42
CHAPTER

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Financial Accounting:1

Tools for Business DecisionMaking Fifth Canadian Edition

Prepared By: Debbie Musil Kwantlen Polytechnic University

Copyright John Wiley & Sons Canada, Ltd.

Reporting and 1 Analyzing Long-Lived Assets

Describe other accounting issues related to depreciation.

Illustrate how long-lived assets are reported in the financial statements.

Property, Plant, and Equipment

Are not intended for sale to customers

Provide benefits over many years

Copyright John Wiley & Sons Canada, Ltd.

Determining the Cost of Property, Plant and Equipment 1

Copyright John Wiley & Sons Canada, Ltd.

Increases a companys investment in productive activity

Copyright John Wiley & Sons Canada, Ltd.

Land has an unlimited life, therefore it is not depreciated

Copyright John Wiley & Sons Canada, Ltd.

Depreciated over their useful lives

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Asset Retirement Costs

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Off-balance sheet financing

Buy or Lease? (Continued)

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Factors In Calculating Depreciation

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Example Depreciation Methods

Copyright John Wiley & Sons Canada, Ltd.

Can be applied using different rates

Diminishing-Balance Method (Continued)

Copyright John Wiley & Sons Canada, Ltd.

Useful for factory machinery, vehicles, airplanes

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Other Depreciation Issues

Income tax Impairments

Cost vs. revaluation model

Revising Periodic Depreciation

Accounted for as a change in estimate

Disposals of Property, Plant, and Equipment 1

2. Calculate carrying amount

3. Calculate gain or loss

Disposals of Property, Plant, and Equipment 1

Copyright John Wiley & Sons Canada, Ltd.

Intangible Assets and Goodwill

Rights, privileges and/or competitive advantages

Must be identifiable either:

Based on contractual or legal rights

Copyright John Wiley & Sons Canada, Ltd.

Accounting for Intangible Assets

Intangible assets with an indefinite (unlimited) life are not amortized

Amortization for Intangibles

Test for impairment

Copyright John Wiley & Sons Canada, Ltd.

Intangibles with Finite Lives

Research and development costs