Ch. 7 Long-Term Assets Flashcards
(44 cards)
1
Q
Capitalize
A
- Record an expenditure as an asset
- We record a long-term asset at its cost PLUS all expenditures necessary to get the asset ready for use. Thus, the initial cost of a long-term asset might be more than just its purchase price
- We capitalize an expenditure as an asset if it increases future benefits. We expense an expenditure if it benefits only the current period.
2
Q
Land improvements
A
- Improvements to land such as paving, lighting, and landscaping that, unlike land itself, ARE SUBJECT TO DEPRECIATION.
- Land is an asset we do not depreciate because its life is indefinite.
- Because land improvements have limited lives, WE RECORD THEM SEPARATELY FROM THE LAND ITSELF.
3
Q
Capitalized interest
A
- Interest costs recorded as assets rather than interest expense.
- The cost of an asset includes ALL costs of making the asset ready for its intended use. If a company borrows money to finance the construction of an asset, the interest paid to borrow the funds logically is part of the asset’s cost.
- Capitalizing interest also is in keeping with the matching principle.
4
Q
Basket purchase
A
- Purchase of more than one asset at the same time for one purchase price.
- ie purchasing land, building, and equipment together for $900,000.
- How much should we record in the separate accounts for the land, the building, and the equipment? We allocate the total purchase price of $900,000 based on the estimated fair values of each of the individual assets.
- The difficulty, though, is that the estimated fair values of the individual assets often exceed the total purchase price.
5
Q
Natural resources
A
- Assets like oil, natural gas, and timber, and even salt that we can physically use up or deplete.
- ie: ExxonMobil maintains oil and natural gas deposits on 6 of the world’s 7 continents. (oil reserves)
- Wyerhaeuser is the largest pulp and paper companies in the world with major investments in soft timber forests.
- Even salt is a natural resource, with the largest supply in the US mined directly under the Great Lakes.
- Primary concern is sustainability. Companies need ways of replenishing natural resources used
6
Q
Intangible assets
A
- Long-term assets that lack physical substance, and whose existence is often based on a legal contract.
- Includes Patents, trademarks, copyrights, franchises, and goodwill.
- Many intangible assets are NOT recorded on the balance sheet at their estimated values. (The reason why is in the “Trademarks” section) (advertising expense related to the trademark is not recorded in B/S)
- Companies acquire intangible assets in two ways:
(1) They PURCHASE intangible assets right from other entities,
(2) They CREATE intangible assets internally, by developing a new product or process and obtaining a protective patent. - The reporting rules for intangible assets vary depending on whether the company purchased or acquired the asset.
7
Q
Patent
A
- An exclusive right to manufacture a product or to use a process.
- The U.S. Patent and Trademark Office grants this right for a period of 20 years.
- When a firm purchases a patent, it records the patent at its purchase price plus such other costs as legal and filing fees to secure the patent.
- When a firm develops a patent internally, it expenses the R&D costs as it incurs them. An exception to this rule is legal fees. (This would be recorded in the Patent asset account)
- Holders of patents often need to defend their exclusive rights in court. The costs of successfully defending a patent, including attorneys’ fees, are added to the Patent account.
- Some may choose to have the patent for less than 20 years (apple ipad because of new technology causing things to become outdated)
8
Q
Copyright
A
- An exclusive right of protection given to the creator of a PUBLISHED WORK such as a song, film, painting, photograph, book, or computer software.
- Protected by law and give the creator (and his/her heirs) the exclusive right to reproduce and sell the work for the life of the creator plus 70 years.
- Accounting for the costs of copyrights is virtually identical to that of patents.
9
Q
Trademark
A
- A word, slogan, or symbol that distinctively identifies a company, product, or service.
- Protected from use by others for a period of 10 years. The registration can be renewed for an indefinite number of 10-year periods, so a trademark is an example of an intangible asset whose useful life can be indefinite.
- Advertising costs can factor into the cost of a trademark in a big way… This is how Coca-Cola can have a trademark valued at $67 billion, but reported in the balance sheet at only $2 billion. THE ESTIMATED VALUE OF THE TRADEMARK IS NOT REPORTED IN THE BALANCE SHEET; instead, only the legal, registration, and design fees are recorded. The advertising costs that create value for the trademark are recorded as advertising expense.
10
Q
Franchises
A
- Local outlets that pay for the exclusive right to use the franchisor company’s name and to sell its products within a specified geographical area.
- Many popular retail businesses such as restaurants, auto dealerships, and hotels are set up as franchises.
- To record the cost of a franchise, the franchisee records the initial fee as an intangible asset and then expenses that cost over the life of the franchise agreement. -Additional periodic payments to the franchisor usually are for services the franchisor provides on a continuing basis, and the franchisee will expense them as incurred.
11
Q
Goodwill
A
- The value of a company as a whole, over and above the value of its identifiable net assets.
- Goodwill equals the purchase price less the fair value of the net assets acquired. The fair value of the net assets is equal to the value of all identifiable assets acquired, minus the value of all liabilities assumed.
- Often the largest, yet most confusing, intangible asset recorded in the balance sheet.
- While most long-term assets, even intangible ones, can be separated from the company and sold individually, goodwill cannot.
- This value can emerge from a company’s reputation, trained employees and management team, its favorable business location, and any other unique features that we are unable to associate with a specific asset.
- We record goodwill as an intangible asset in the B/S ONLY WHEN WE PURCHASE IT AS PART OF THE ACQUISITION OF ANOTHER COMPANY.
12
Q
Repairs and maintenance
A
- Expenses that maintain a given level of benefits in the period incurred. (cost of an engine tune-up or the repair of an engine part for a delivery truck)
- We capitalize as assets more extensive repairs that increase the future benefits of the delivery truck, such as new transmission or an engine overhaul.
13
Q
Addition
A
- Occurs when a new major component is added to an existing asset.
- We should capitalize the cost of additions because they increase, rather than maintain the future benefits from the expenditure.
14
Q
Improvement
A
- The cost of replacing a major component of an asset.
- The cost of the improvement usually increases future benefits, and we should capitalize it to the Equipment account.
15
Q
Material
A
- Large enough to influence a decision.
- Materiality is an important consideration in the “capitalize vs expense” decision.
- Companies generally expense all costs under a certain dollar amount, say $1,000, regardless of whether future benefits are increased. (ie: a stapler may have a 20-year service life, but it would not be practical to capitalize and then allocate that small of a cost to expense over 20 years.
16
Q
Depreciation
A
Allocation of the cost of a TANGIBLE asset over its service life. This term applies to property, plant, and equipment.
- Depletion: describes the cost allocation applying to natural resources
- Amortization: describes the cost allocation applying to intangible assets.
17
Q
Accumulated Depreciation
A
- A contra asset account representing the total depreciation taken to date.
- By increasing accumulated depreciation each period, we are reducing the book value of equipment.
- Accumulated Depreciation account allows us to reduce the book value of assets through depreciation, while maintaining the original cost of each asset in the accounting records.
18
Q
Book Value
A
Equal to the original cost of the asset minus the current balance in Accumulated
Depreciation.
-Can also be called Carrying value.
19
Q
Service life
A
- How long the company expects to receive benefits from the asset before disposing of it; also referred to as Useful life.
- We can measure service life in units of time or in units of activity. (ie: the estimated service life of a delivery truck might be either 5 years or 100,000 miles.
20
Q
Residual value
A
The amount the company expects to receive form selling the asset at the end of its service life; also referred to as salvage value.
- A company might estimate residual value from prior experience or by researching the resale values of similar types of assets.
- Due to the difficulty in estimating residual value, it’s not uncommon to assume a residual value of zero.
21
Q
Straight-line method
A
- Allocates an equal amount of depreciation to each year of the asset’s service life.
- Most easily understood and widely used method.
- Formula: Asset’s cost - Residual Value / Service life.
- Asset’s cost - Residual Value equals Depreciable cost.
- Measure depreciation based on time.
- Results in higher net income
22
Q
Accelerated depreciation method
A
- Allocates a higher depreciation in the earlier years of the asset’s life and lower depreciation in later years.
- Assumes that the asset will provide greater benefits in the earlier years of its life than in the later years.
- Better matching of depreciation with revenues.
- Declining-Balance depreciation is an accelerated depreciation method.
23
Q
Declining-balance method
A
An accelerated depreciation method that records more depreciation in earlier years and less depreciation in later years.
-Measure depreciation based on time.
24
Q
Activity-based method
A
Allocates an asset’s cost based on its use.
- Also can be called units of production or units of output.
- Measure depreciation based on units
- ie: we could measure the service life of a machine in terms of its output (units, pounds, barrels) or delivery truck in miles.
25
Depletion
Allocation of the cost of a natural resource over its service life.
26
Amortization
Allocation of the cost of an intangible asset over its service life.
27
Return on assets
Net income divided by average total assets; measures the amount of net income generated for each dollar invested in assets.
28
Profit margin
Net income divided by net sales; indicates the earnings per dollar of sales.
29
Asset turnover
Net sales divided by average total assets, which measures the sales per dollar of assets invested.
30
Impairment
Occurs when the future cash flows (future benefits) generated for a long-term asset fall below its book value (cost minus accumulated depreciation).
31
Big bath
* Recording all losses in one year to make a bad year even worse.
- Managers sometimes use the recording of impairment losses to their advantage.
- Some companies time their impairment losses with other one-time losses such as losses on sales of assets, inventory write-downs, and restructuring charges, to record a big loss in one year.
- Management thus cleans its slate and is able to report higher earnings in future years.
- Future earnings are higher because the write-down of assets in this year results in lower depreciation and amortization charges in the future.
32
Long-Term Assets
- Tangible Assets: (can also be called property, plant, and equipment; plant assets; or fixed assets). Include land, land improvements, buildings, equipment, and natural resources.
- Intangible Assets: Include patents, trademarks, copyrights, franchises, and goodwill. Lack physical substance. Evidence of their existence often is based on a legal contract.
33
Property, Plant, and Equipment (Acquisitions)
- Capitalize
- When making an expenditure, we have the choice of recording it as an expense of the current period, or recording it as an asset and then allocating that cost as an expense over future periods.
- Determining which costs to record as expenses and which to record as long-term assets is crucial.
34
Capitalized costs for land
- Include purchase price of the land plus closing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording fees.
- If the property is subject to back taxes or other obligations, we include these amounts as well.
- Also additional expenditures such as clearing, filling, and draining the land, or even removing old buildings to prepare the land for its intended use.
- If we receive any cash from selling salvaged materials from old buildings torn down, we reduce the cost of land by that amount.
35
Back Taxes
- Land
- Unpaid taxes from previous years
- This is the amount required to get the asset ready for use. You cannot use the land until you pay the back taxes
- The additional amount in property taxes, though, relates only to the current period.
36
Building's acquisition cost
- The cost of acquiring a building usually includes realtor commissions and legal fees in addition to the purchase price.
- The new owner sometimes needs to remodel or otherwise modify the building to suit its needs.
- Unique accounting issues arise when a firm constructs a building rather than purchasing it. (Cost of construction- architect fees, material costs, construction labor, officer supervision, overhead, capitalized interest)
37
Cost of Equipment
- The cost of equipment is the actual purchase price plus all other costs necessary to prepare the asset for use.
- This includes sales tax, shipping, delivery insurance, assembly, installation, testing, and even legal fees incurred to establish title.
- RECURRING COSTS related to equipment such as annual property insurance and annual property taxes on vehicles: Rather than including them as part of the cost of the equipment, we expense them as we incur them, in order to properly match them with revenues generated during the same period.
38
Reporting PURCHASED Intangible Assets
- Similar to reporting purchased property, plant, and equipment.
- We record purchased intangible assets at their original cost plus all other costs, such as legal and filing fees, necessary to get the asset ready for use.
39
Reporting Intangible Assets that are developed INTERNALLY.
- Rather than recording these on the balance sheet as intangible assets, we expense to the income statement most of the costs for internally developed intangible assets as we incur those costs.
- ie: the Research and Development (R&D) costs incurred in developing a patent internally are not recorded as an intangible asset in the balance sheet. Instead they are expensed directly in the income statement. This is because of the difficulty in determining the portion of R&D that benefits future periods. (Similar to advertising expenses. Advertising costs are not recorded as intangible assets on the balance sheet).
40
Legal Defense of Intangible Assets
- If a firm successfully defends an intangible right, it should capitalize the litigation costs and amortize them over the remaining useful life of the related intangible.
- However, if the defense of an intangible right is unsuccessful, then the firm should expense the litigation costs as incurred because they provide no future benefit.
41
3 most common depreciation methods used in practice
- Straight-line
- Declining-balance
- Activity-based
42
MACRS
IRS prescribed this method for income tax purposes. Thus companies record higher net income using straight-line depreciation and lower taxable income using MACRS depreciation
-MACRS combines declining-balance methods in earlier years with straight-line in later years to allow for a more advantageous tax depreciation deduction.
43
Intangible assets not subject to amortization
- Intangible assets with indefinite useful lives
- most trademarks
- goodwill
- This does not mean that goodwill and other intangible assets with indefinite useful lives will remain on a company's balance sheet at their original cost forever
- Management must review long-term assets for a potential write-down when events or changes in circumstances indicate the amount recorded for an asset in the accounting records might not be recoverable (impairment rules)
44
Asset Disposition
- Sale
- Retirement: When a long-term asset is no longer useful but cannot be sold.
- Exchange: Two companies trade assets
