Chapter 10: Plant Assets, Natural Resources, and Intangible Assets Flashcards
Patents
An intangible asset
The exclusive right to manufacture/ sell/ control an invention for 20 years from date of grant
Capitalize - cost of purchasing, legal fees of SUCCESSFULLY defending patent
Amortize directly (no contra-asset) over useful life or 20 years, whichever is shorter
Expense R&D Costs
Intangible Assets
Rights, privileges, competitive advantages that do NOT possess physical substance
Categorized as having either a limited life or indefinite life (also internally created vs purchased)
Trademarks, patents, goodwill, copyrights, franchises/ licenses
Natural Resources
AKA Wasting assets
- physically extracted in the course of operations
- replaceable only by act of nature
Uses depletion to spread cost across usage until used up
Impairment
A permanent decline in asset value (down to LESS than book value)
intangible assets are tested for impairment annually and if it occurs the company records a loss in the period the decline is identified
Depreciation
A process of cost allocation (not asset valuation)
- expenses to period that benefits from the use of the asset (matching principle)
- Does NOT apply to land
- Shows how revenue producing ability declines over an assets natural life
- Depreciation stops when book value = salvage value
Plant assets
Includes land improvements Attributes: - Possess physical substance - Used in operations - Not for Resale to Customers - Long-Term - Usually a depreciated expense
AKA: property, plant and equipment, PP&E, Plant + Equipment, or Fixed Assets
Salvage Value
Estimate of an asset’s value at the end of its useful life. (also “residual value”)
Cost of Plant assets
DOES NOT INCLUDE MAINTENANCE AND UPKEEP
- Always at historical cost (cost principle)
- The asset is shown at historical cost of its entire useful life. Contra-asset accounts shows depreciation
- Cost includes all necessary expenditures to acquire asset and make it ready for use, including:
Fees and commissions, closing costs, cost to make ready (improvements, removals) Taxes, freight, discounts, trial runs
- interest costs are included ONLY during construction and only if its a significant period of time.
Classes of Plant Assets
- Land (for use in ops, NOT investment property)
- Land improvements (driveways, parking lots, etc.. have limited useful life)
- Building (used in ops, not investments)
- Equipment
Types of expenditures on plant assets
Ordinary Expenditures (Revenue Expenditures) - maintaining operating efficiency, shows in expenses for that period
Capital Expenditures (Additions and Improvements)
- Increases the operating efficiency, capacity or useful life
- Debit the plant asset effected
- Depreciated over its useful life
Modified Accelerated Cost Recovery System
MACRS
- Required by the IRS, but not acceptable under GAAP
- Assets divided by IRS regulation into specific classes that determine useful life
- Ignores residual value
Accelerated Depreciation Methods
Expense more of the assets cost at the start of its useful life and less at the end
Capital Expenditure vs Revenue Expenditure
Capital Expenditure:
- Balance Sheet Expenditure
- Debited to an asset account
Revenue Expenditure:
- Debited to Expense Account
- Income Statement Expenditure
Extraordinary Repair
Repair work that generates a capital expenditure because it extends the assets life past the normal expected life
debited to an asset account
Land Improvements
A depreciable improvement to the land such as fencing, sprinklers, paving, signs or lighting
NOT included as cost of the land (which does not depreciate) but as individual depreciable assets
(to) Capitalize
Recording the acquisition of land, building or other assets by debiting (increasing) an asset account
Copyrights
Exclusive right to reproduce and sell artistic or published work
Granted for the life of the creator + 70 years (depends on the date of publication)
Capitalize: Acquisition cost + Successful cost to defend
Amortize over useful life (usually a short period)
Amortization
Decreases asset directly over useful life, no contra-asset account required. (Though may choose to use one)
Means the asset disappears from the books at the end of its useful life - no need to discard/ no physical asset to dispose of
Trademark / Trade Names
An intangible asset
Legal protection for an indefinite number of 20 year renewal periods. Indefinite life
Capitalize- Acquisition costs
Expense - cost to develop or maintain as they are incurred
No amortization allowed under GAAP
Franchises and Licenses
Arrangement between a franchisor and franchisee
- licenses and permits are a type of franchise between a government body and a business over the use of public property
- Franchise with limited life: cost to acquire amortized to expense over life of franchise
-Indefinite life, carried at cost, not amortized
Goodwill
Intangible, indefinite asset
ONLY recorded when entire business is purchased - cannot be sold separately
- internally created goodwill not capitalized
-no amortization allowed (indefinite life)
value = purchase price of business - fair market value of net asset acquired
Modified Half-Month convention
Alternative to calculating partial month or daily depreciation for partial year depreciation
An asset purchased on/ before the 15th of a month will be depreciated for the whole month
An assert purchased after the 15th will not be depreciated until following month
Commercial substance
Exchanges have commercial substance if future cash flows change as a result of the exchange
Intangible asset amortization periods
Patents: 20 year legal life, amortized over useful or legal life
Franchises/Licenses: Legal life by contract or indefinite, amortized over useful life
Copyrights: Legal = life of creator + 70 years, Amortized over short period (useful life)
Goodwill: indefinite legal life, not amortized
Trademarks/Trade Names: Indefinite legal life, Not amortized
Journaling Exchange of Equipment/ Plant Assets
Debit Equipment (new)
Debit Accumulated Depreciation
Debit Any Loss on Exchange
Credit Equipment (old)
Credit Cash paid
Credit any gain on ExchangeJournaling Plant Asset Disposal
Disposed by: sale, exchange or retirement (scrapped/ discarded)
Depreciation must be recorded up until the date of disposal (must be brought up to date before journaling disposal) or until book value = salvage value
Debit Accumulated Depreciation
Credit Asset Account
+ recognize any value received or loss (of salvage value)
Recording Depletion Expense
Debut Depletion Expense
Credit Accumulated Depletion
Accumulated depletion = contra-asset account
Limited life intangibles
- Amortize to expense over asset’s useful life
- no contra-asset account. Credit asset account directly
Debit Amortization Expense
Credit Asset Account
Indefinite Life Intangibles
No amortization allowed per GAAP
Internally Created Intangibles
- Generally expensed as costs incurred (no amortization/ depreciation)
Exceptions: can capitalize direct costs to register, defend, or perfect title and internally created assets (legal costs)
Research and Development Costs
Always expensed when incurred (whether successful or not)
Purchased Intangibles
- Recorded at cost (includes all costs to make ready for use)
- Amortized over (limited) useful life (allocated to periods benefited
- At disposal asset is eliminated and gains or losses recorded
Journal Periodic Depreciation Accumulation
Debit Depreciation Expense
Credit Accumulated Depreciation
Capital Expenditures
Debit Asset Account
Credit Cash or A/R
Revising Periodic Depreciation
Allowable by GAAP - a change in the estimate
- change in current and future periods of depreciation, no retrospetive changes
Revised depreciation expense = Revised depreciable cost / remaining useful life
(Revised depreciable cost = current book value - current salvage value)
Natural Resource Depletion Expense
Acquisition cost = cost to acquire + cost to prepare for use
Depletion: allocated over resources’ useful life
Use units of activity depletion - based on units extracted/ year
(Acquisition cost - Salvage Value)/ estimated units available = cost per unit
Depletion expense = units extracted (and sold) x Depletion cost per unit
Goodwill Calculation
= purchase prices - fair market value of net assets acquired
Net Assets = total assets - total liabilities
Asset Turnover Ratio
= Net Sales/ Average Total Assets
Average Total Assets= (Beginning assets + ending assets)/ 2
Measures how efficiently a company uses assets to generate sales
shows amount of sales each dollar invested in assets produces
Computing depreciation
Need:
- Cost (all expenditures to acquire and make ready)
- Useful life (estimated based on expected repairs, service life, obsolesce)
- Salvage Value
Want to use best method to represent actual contribution to revenue
- Straight line (most used)
- units of activity
- Declining balance
multiply by fraction of a year if its a partial year
Depreciable Cost
Asset cost less salvage value
Relative Market Value Method
A method of allocating the total cost of multiple assets purchased at one time (lump sum or basket). Total cost is divided among the assets according to their relative value.
1) Find market value of each asset
2) Calculate what percentage that is of total market value
3) use that percentage to calculate relative market value
Units-of-Activity Depreciation Method
AKA Units of Production Method
(Depreciable cost / estimated total units of activity) x activity units per year = depreciation amount for year
units can be qty or hours
Often difficult to estimate total activity but results in the best matching of revenues and expenses if productivity varies between periods
Good for items that depreciate from wear and tear
(Double) Declining balance method of depreciation
An Accelerated depreciation method. Multiples depreciable assets decreasing book value by a constant percentage that is 2x the straight line depreciation rate.
= book value x 2 x (1/useful life)
(aka book value x (2/useful life)
Book value = cost - accumulated depreciation. Changes yearly
Residual value is ignored until depreciation would take book below residual and then residual is plugged
Called declining balance because book value AND depreciation expense decline each year
higher depreciation in early years = higher output from new asset
Straight Line Depreciation
Depreciable cost / useful life (years) = annual depreciation expense
- Depreciation is the same each year
- Matches the expenses and revenues if asset is used fairly uniformly throughout service life (often items that become obsolete)
Intangible assets on financial statements
Usually shown as a separate category from PP&E
(Natural resources listed under PP&E)
Shown only at net book value - amortization expense as an operating expense
Depreciation and Taxes
IRS does not require companies to use the same depreciation method on financial statments and taxes
Taxes require MACRS (may allow straight line method, book and presentation disagree)
MACRS= Modified Accelerated Cost Recovery System (not allowed under GAAP)
How Depreciation is shown on financial reports
Income statement: shows depreciation expense
Balance sheet: shows asset and accumulated depreciation
Result of incorrect capitalization
Capitalization delays expense recognition to future periods - boost current period profits.
Gains or Losses on PP&E on Financial Statements
Goes in Other Revenue and Gains or Other Expenses and Losses (not an operating expenses)
IFRS - Component Depreciation
Any significant parts of a depreciable asset that have different estimated useful lives should be separately depreciated.
Required by IFRS
Long-lived assets under IFRS
R&D expensed under GAAP, NOT under IFRS
IFRS uses “residual value” not salvage value
IFRS allows companies to re-value assets to Fair Market Value as of Reporting Date
- must be applied to all assets in that asset class
- if asset is experiencing rapid changes in value must re-evaluate annual
- Requires component depreciation
- IFRS allows revaluation of intangible assets (besides goodwill) GAAP does not.
