Chapter 7 Notes Flashcards
Tangible assets
Assets that have physical substance.
Intangible assets
Assets that lack physical substance and often exist based on legal contracts.
Land
Includes the cost of the land and all expenditures necessary to get the land ready for its intended use.
Land improvements
Amounts spent to improve the land, such as parking lots, sidewalks, and landscaping.
Buildings
Structures that are permanently attached to the land.
Equipment
Machinery and tools used in operations.
Natural resources
Assets that are extracted or harvested, such as minerals and oil.
Patents
Exclusive rights granted for an invention for a certain period.
Trademarks
Symbols, names, or slogans used to identify goods or services.
Copyrights
Legal rights that grant the creator of original work exclusive rights to its use and distribution.
Franchises
Rights granted to operate a business under a certain brand or business model.
Goodwill
An intangible asset that arises when a company acquires another for more than the fair value of its net identifiable assets.
Property, Plant, and Equipment
Recorded at the original cost of the asset plus all expenditures necessary to get the asset ready for use.
Cost of Land
Total capitalized cost of land includes purchase price, commissions, back property taxes, title insurance, and leveling costs, minus any cash received from salvaged materials.
Common Mistake
Students often incorrectly add or ignore cash received from the sale of salvaged materials, which reduces the total cost of land.
Accumulated depreciation
The total amount of depreciation expense that has been recorded against an asset over time.
Total current assets
The sum of all current assets, which includes cash, receivables, inventories, and other current assets.
Balance Sheet
A financial statement that summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time.
Cash and cash equivalents
Liquid assets that are readily available for use.
Receivables
Amounts owed to a company by customers for goods or services delivered.
Inventories
Goods available for sale in the normal course of business.
Films and television costs
Costs associated with producing films and television shows.
Investments
Assets held for generating income or appreciation.
Buildings
Administrative offices, retail stores, manufacturing facilities, and storage warehouses.
Costs of getting a building ready for use
Include items such as realtor commissions and legal fees, remodeling costs.
Unique accounting issues for building construction
Arise when a firm constructs a building rather than purchasing it (capitalize interest cost).
Equipment
Machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures.
Cost of equipment
Might include sales tax, shipping, assembly, and any other costs to prepare the asset for use.
Recurring costs for equipment
Such as annual property insurance and annual property taxes on vehicles are expensed as incurred.
Capitalized Cost of Equipment
Costs necessary to get the equipment ready for use total $91,000.
Basket Purchases
Purchase of more than one asset at the same time for one purchase price.
Recording assets in basket purchases
We need to record each of the assets acquired (e.g., land, building, and equipment) in separate accounts.
Allocation of total purchase price in basket purchases
Based on the relative fair values of the individual assets.
Olive Garden basket purchase example
Purchases land, building, and equipment together for $900,000 with estimated fair values of $200,000, $700,000, and $100,000.
Land allocation in basket purchase
$180,000 recorded for land based on its fair value percentage.
Building allocation in basket purchase
$630,000 recorded for building based on its fair value percentage.
Equipment allocation in basket purchase
$90,000 recorded for equipment based on its fair value percentage.
Concept Check 7-1
A company makes a basket purchase of land, buildings, and equipment with estimated fair values of $70,000, $150,000, and $30,000, respectively.
Purchase price for Concept Check 7-1
$210,000 is the total purchase price allocated to the separate accounts for Land, Buildings, and Equipment.
Land’s relative fair value in Concept Check 7-1
28% (or $70,000 ÷ $250,000) of the total estimated fair value.
Recorded amount for Land in Concept Check 7-1
$58,800 (or $210,000 × 28%).
Natural Resources
Examples include oil, natural gas, timber, and salt.
Distinction of natural resources
They are physically used up, or depleted.
Recording natural resources
Recorded at cost plus all other costs necessary to get the natural resource ready for its intended use.
Natural Resources
Distinguished from other assets by the fact that they are physically used up, or depleted.
Natural Resources
Recorded at cost plus all other costs necessary to get the natural resource ready for its intended use.
Tangible Assets
Such as land, land improvements, buildings, equipment, and natural resources are recorded at cost plus all costs necessary to get the asset ready for its intended use.
Intangible Assets
Include patents, trademarks, copyrights, franchises, and goodwill.
Purchased Intangibles
Record at their original cost plus all other costs necessary to get the asset ready for use.
Internally Developed Intangibles
Expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs.
Research and Development (R&D)
Costs incurred to conduct research and to develop a new product or process.
Research and Development (R&D)
Not reported as an intangible asset in the balance sheet.
Research and Development (R&D)
Reported as an expense in the income statement rather than as an intangible asset in the balance sheet.
Advertising
Difficult to estimate benefits in future periods.
Advertising
Not reported as intangible asset in the balance sheet.
Advertising
Reported as expenses in the income statement in the period incurred.
Purchased Intangibles
We record purchased intangibles as long-term assets at their purchase price plus all costs necessary to get the asset ready for use.
Internally Generated Intangibles
We expense internally generated intangibles, such as R&D and advertising costs, as we incur them.
Patents
Exclusive right to manufacture a product or to use a process.
Patents
Granted for a period of 20 years.
Purchased Patents
Capitalize the purchase price plus legal and filing fees.
Internally Developed Patents
Capitalize legal and filing fees only (Research and Development costs are expensed as incurred).
Cost of Patent
A company obtains two patents during the year: Patent #1 was purchased from another company for $200,000. Patent #2 was developed internally at a cost of $200,000.
Patent
An exclusive right to manufacture a product or to use a process.
Copyright
An exclusive right of protection given to the creator of a published work, granted for the life of the creator plus 70 years.
Trademark
A word, slogan, or symbol that distinctively identifies a company, product, or service, renewable for an indefinite number of 10-year periods.
Franchise
Local outlets that pay for the exclusive right to use the franchisor’s name and to sell its products within a specified geographical area.
Goodwill
The portion of the purchase price that exceeds the fair value of identifiable net assets, recorded only when one company acquires another company.
Research and Development Expense
Costs incurred in the internal generation of intangible assets, which must be expensed.
Cash Expenditures for Patent #2
200000
Legal Fees for Patents
$40,000 for both patents.
Filing Fees for Patents
$5,000 for both patents.
Intangible Assets
Assets that have no physical substance and generally represent exclusive rights that provide benefits to owners.
Fair Value of Identifiable Net Assets
Total fair value of assets acquired minus total fair value of liabilities assumed.
Recording Goodwill
The process of accounting for goodwill when one company acquires another company.
Accounts Receivable Fair Value
$10 million.
Equipment Fair Value
$32 million.
Patent Fair Value
$8 million.
Total Fair Value of Assets
$50 million.
Total Fair Value of Liabilities
$24 million.
Purchase Price Paid by Allied Foods
$36 million.
Goodwill Amount
$10 million.
Advertising Costs
Expensed as incurred.
Legal, Registration, and Design Fees for Trademarks
Capitalized.
Additional Payments to Franchisor
Usually expensed as incurred.
Concept Check 7-2
Which of the following is an exclusive right to manufacture a product or to use a process? a. Trademark b. Patent c. Copyright
Patent
An exclusive right to manufacture a product or to use a process, granted for a period of 20 years.
Expenditures After Acquisition
Additional expenditures associated with a long-term asset incurred by the owners over the life of the asset.
Capitalize
To record an expenditure as an asset if it benefits future periods.
Expense
To record an expenditure as an expense if it benefits only the current period.
Materiality
An item is said to be material if it is large enough to influence a decision.
Non-material Expenditures
Typically recorded as an expense regardless of its expected period of benefit.
Cost Policy
Companies generally have policies regarding amounts that are not material, expensing all costs under a certain dollar amount, say $1,000.
Current Expense
Costs associated with maintaining a given level of benefits, such as repairs and maintenance.
Future Capitalize
Costs that involve making major repairs or adding new components that increase future benefits.
Legal Defense of Intangible Assets
Costs incurred to defend the legal right to the asset, expensed if the defense is unsuccessful.
Depreciation
The allocation of an asset’s cost to expense over time.
Decrease in Value
The reduction in value (or selling price) of an asset.
Depreciation Calculation
Depreciation = Allocation of a portion of the asset’s cost to an expense over all periods benefited.
Tune-up Expense
The cost of a tune-up on a delivery truck should be expensed as it is necessary to maintain the truck.
Adding Refrigeration Unit
This cost would be capitalized as it benefits future periods.
New Suspension System
This cost would be capitalized as it allows for heavier loads and benefits future periods.
New Transmission
This cost would be capitalized as it increases the life and future benefits of the delivery truck.
Repairs and Maintenance
Costs that are typically expensed as they maintain the current level of benefits.
Major Repairs
Costs that are capitalized if they increase future benefits.
Adding a New Major Component
This cost would be capitalized as it adds future benefits.
Improvements
Costs that are capitalized if they enhance the asset’s future benefits.
$ Cost
The total amount paid for an asset.
$ Benefit
The advantages or returns received from using an asset.
Common Mistake
Students sometimes mistake accounting depreciation as recording the decrease in value of an asset.
Depreciation in accounting
An allocation of an asset’s cost to expense over time.
Recording Depreciation
The process of documenting the depreciation expense in financial records.
Depreciation Expense
The amount charged to expense for the use of an asset during a specific period.
Accumulated Depreciation
The total depreciation expense that has been recorded against an asset over time.
Book value
The value of an asset after accounting for accumulated depreciation.
Service life
The estimated use the company expects to receive from the asset before disposing of it.
Residual value
The amount the company expects to receive from selling the asset at the end of its service life.
Depreciation method
The pattern in which the asset’s depreciable cost is allocated over time.
Straight-line method
A depreciation method where the same amount is expensed each year.
Declining-balance method
A depreciation method that expenses a higher amount in the earlier years of an asset’s life.
Activity-based method
A depreciation method based on the asset’s usage or activity level.
Depreciable cost
The original cost of the asset minus its residual value.
Depreciation expense formula
Depreciation expense = (Asset’s cost − Residual value) / Service life.
Cost of the new truck
40000
Estimated residual value
5000
Estimated service life
5 years or 100,000 miles.
Straight-Line Depreciation Expense
$7,000 per year.
Depreciation Schedule
A table showing the depreciation expense and accumulated depreciation over time.
Partial-Year Straight-Line Depreciation
Depreciation calculated for a partial year based on the straight-line method.
Depreciation Schedule—Straight-Line
A table that outlines the annual depreciation expense and accumulated depreciation over the asset’s useful life.
Common Mistake (March 1 to year-end)
Many students incorrectly calculate March 1 to the end of the year as nine months instead of the correct ten months.
Land Depreciation
Depreciation is recorded for land improvements, buildings, and equipment, but not for land itself.
Common Mistake (Depreciating Land)
Some students mistakenly depreciate land, not realizing its service life never ends.
Annual Depreciation Calculation
$5,000 = ($30,000 − $5,000) ÷ 5 years.
Depreciation from April 1 to December 31
$3,750 = $5,000 × 9/12.
Change in Depreciation Estimate
Adjusting the estimated service life and residual value of an asset affects future depreciation calculations.
New Depreciable Cost Calculation
New depreciable cost = Book value - New residual value.
Annual Depreciation in Years 4 to 7
$4,000 annual depreciation calculated based on new estimates.
Double-Declining-Balance Depreciation
A method of depreciation that accelerates the expense recognition by applying a double rate to the declining book value.
Beginning Book Value
The original cost of the asset before any depreciation is applied.
Accumulated Depreciation
The total depreciation expense that has been recorded against an asset since it was acquired.
Book Value Calculation
Book value = Original cost - Accumulated depreciation.
Depreciation Expense Calculation
Depreciation expense = Beginning book value × Depreciation rate.
Total Depreciation
The sum of all depreciation expenses recorded over the asset’s useful life.
Residual Value
The estimated value of an asset at the end of its useful life.
Service Life
The expected duration over which an asset will be used in operations.
Straight-Line Method
A method of depreciation where the asset’s cost is evenly spread over its useful life.
Double Declining Rate
A depreciation rate that is double the straight-line rate applied to the declining book value.
Depreciation Expense for Year 1
$16,000 calculated using the double-declining-balance method.
Depreciation Expense for Year 2
$9,600 calculated using the double-declining-balance method.
Depreciation Expense for Year 3
$5,760 calculated using the double-declining-balance method.
Depreciation Expense for Year 4
$3,456 calculated using the double-declining-balance method.
Book value at the end of year 1
Equal to book value at the beginning of year 2.
Residual value
The amount necessary to reduce book value to this value.
Common Mistake in Declining-Balance Method
Mistakes are commonly made in the first and last year of the calculation.
First year depreciation calculation mistake
Students sometimes calculate depreciation incorrectly as cost minus residual value times the depreciation rate.
Correct first year depreciation calculation
Multiply cost times the depreciation rate.
Final year depreciation calculation mistake
Some students incorrectly calculate depreciation expense by multiplying book value by the depreciation rate.
Final year depreciation under declining-balance method
Depreciation expense is the amount necessary to reduce book value down to residual value.
Cost of delivery truck
30000
Expected life of delivery truck
Six years.
Estimated residual value of delivery truck
6000
Double-declining-balance method first year depreciation
$10,000 = $30,000 × 33.33%.
Straight-line rate for a six-year asset
1/6, which is doubled to 2/6 (or 33.33%).
Estimated residual value of new truck
5000
Estimated service life of new truck
5 years or 100,000 miles.
Depreciable cost formula
Cost - Residual value.
Depreciation rate per unit
$0.35 per mile.
Total units expected to be produced
100,000 expected miles.
Depreciation Schedule for LITTLE KING SANDWICHES
Shows end-of-year amounts based on miles driven.
Total depreciation for all methods
35000
Comparison of Depreciation Methods
Shows depreciation expense for Straight-Line, Double-Declining Balance, and Activity-Based methods.
Depreciation Expense Over Time
Illustrates depreciation expense for three methods over five years.
Use of Various Depreciation Methods
Distribution of methods used: Straight-Line (92%), Declining-Balance (4%), Activity-Based (3%), Other (1%).
Tax Depreciation
Accelerated methods reduce taxable income more in the earlier years of an asset’s life.
MACRS
An accelerated method used for tax reporting.
Straight-line Depreciation
A method of depreciation where the asset’s cost is evenly allocated over its useful life, commonly used for financial reporting.
Declining-balance Depreciation
A method of depreciation that applies a constant rate to the declining book value of the asset.
Activity-based Depreciation
A method of depreciation that allocates costs based on the asset’s usage or activity level.
Amortization of Intangible Assets
Allocating the cost of intangible assets to expense.
Finite Useful Life
The estimated duration over which an intangible asset can provide economic benefits, often limited by legal, regulatory, or contractual provisions.
Straight-line Amortization
A method used by most companies to amortize intangible assets evenly over their useful life.
Franchise Rights
Intangible assets acquired for a specific period, such as the $800,000 franchise rights for 20 years in the example.
Patent
An intangible asset that grants exclusive rights to an invention for a certain period, such as the $72,000 patent with 12 years remaining in the example.
Amortization Expense
The expense recorded for the allocation of intangible assets’ costs, such as $40,000 for the franchise and $9,000 for the patent.
Goodwill
An intangible asset with an indefinite useful life that is not subject to amortization.
Trademark with Indefinite Life
An intangible asset that can be renewed indefinitely and is not amortized.
Copyright
An intangible asset that protects original works of authorship, subject to amortization.
Franchise
An intangible asset that allows the operation of a business under a brand for a specified period.
Intangible Assets Subject to Amortization
Assets with finite useful lives, including patents, copyrights, trademarks with finite life, and franchises.
Intangible Assets Not Subject to Amortization
Assets with indefinite useful lives, including goodwill and trademarks with indefinite life.
Concept Check 7-6
A question assessing knowledge of which intangible assets are not subject to amortization.
Service Life of Intangible Asset
The estimated duration over which an intangible asset is expected to provide economic benefits.
Asset Disposal
The process of selling, retiring, or exchanging long-term assets.
Learning Objective 5
Calculate amortization of intangible assets.
Learning Objective 6
Account for the disposal of long-term assets.
Disposal of Long-Term Assets
Occurs when a long-term asset is no longer useful but cannot be sold.
Common Mistake in Asset Disposal
Some students forget to update depreciation prior to recording the disposal of the asset.
Depreciation Requirement
Depreciation must be recorded up to the date of the sale, retirement, or exchange.
Overstated Book Value
If depreciation is not updated, the book value will be overstated, and the resulting gain or loss on disposal will be in error.
Original Cost of the Truck
40000
Estimated Residual Value
5000
Estimated Service Life
5 years
Straight-Line Depreciation
7000
Gain on Sale
Little King sells the truck at the end of Year 3 for $22,000.
Sale Amount
22000
Accumulated Depreciation
(3 years × $7,000/year) = $21,000
Book Value at the End of Year 3
19000
Gain
3000
Recording Sale for Gain
Debit Cash $22,000, Debit Accumulated Depreciation $21,000, Credit Equipment $40,000, Credit Gain $3,000.
Common Mistake in Recording Sale
Be careful not to combine the delivery truck and accumulated depreciation and credit the $19,000 difference to the Equipment account.
Loss on Sale
Little King sells the truck at the end of Year 3 for $17,000.
Loss Amount
-2000
Recording Sale for Loss
Debit Cash $17,000, Debit Accumulated Depreciation $21,000, Debit Loss $2,000, Credit Equipment $40,000.
Retirement of Long-Term Assets
Little King’s truck is totaled in an accident at the end of year 3.
Sale Amount on Retirement
0
Loss on Retirement
-19000
Recording Loss on Retirement
Debit Accumulated Depreciation $21,000, Debit Loss $19,000, Credit Equipment $40,000.
Sale amount
7000
Cost of equipment
20000
Accumulated Depreciation
15000
Book value
5000
Gain on sale
2000
Trade-in Allowance
23000
Accumulated depreciation (3 years)
21000
Gain
4000
Asset disposal gain
Recorded when an asset is disposed of for more than its book value.
Asset disposal loss
Recorded when an asset is disposed of for less than its book value.
Return on Assets
Indicates the amount of net income generated for each dollar invested in assets.
Return on Assets formula
Return on Assets = Net income / Average total assets
Common mistake in Return on Assets calculation
Dividing by ending total assets rather than average total assets.
Average total assets
Used in the denominator to align the timing of the numerator and denominator in ratio analysis.
Net sales for Disney
$69,570 million
Net income for Disney
$11,584 million
Total assets, beginning for Disney
$98,598 million
Total assets, ending for Disney
$193,984 million
Net sales for Netflix
$20,156 million
Net income for Netflix
$1,867 million
Total assets, beginning for Netflix
$25,974 million
Total assets, ending for Netflix
$33,976 million
Return on Assets for Disney
0.079
Return on Assets for Netflix
0.062
Profit margin
Indicates the earnings per dollar of sales.
Asset turnover
Measures the sales per dollar of assets invested.
Profit Margin for Disney
$11,584 ÷ $69,570 = 16.7%
Profit Margin for Netflix
$1,867 ÷ $20,156 = 9.3%
Asset Turnover for Disney
$69,570 ÷ (($98,598 + $193,984)/2) = 0.48 times
Asset Turnover for Netflix
$20,156 ÷ (($33,163 + $36,347)/2) = 0.67 times
Profit margin calculation
Computed by taking net income and dividing by net sales.
Papa’s Pizza profit margin
Net income of $2,223 divided by net sales of $24,128 results in a profit margin of 9.2%.
Impairment of long-term assets
Occurs when the expected future cash flows generated for a long-term asset fall below its book value.
Two-Step Impairment Process
Step 1: Test for impairment. Step 2: If impaired, record impairment loss.
Test for Impairment
Determines if future cash flows are less than book value.
Loss calculation for impairment
Loss equals book value of asset minus fair value of asset.
Little King’s trademark impairment
Book value of $50,000, estimated future cash flows of $20,000, estimated fair value of $12,000.
Impairment loss recording
Record an impairment loss only when book value exceeds estimated future cash flows.
Common Mistake in impairment
Some students forget step 1 when considering impairment.
Impairment loss criteria
Record an impairment loss only when book value exceeds both future cash flows and fair value.
Impairment loss amount
The impairment loss is the amount by which book value exceeds fair value.
Step 1 of impairment process
A long-term asset with a finite life is impaired if future cash flows are less than book value.
Step 2 of impairment process
If impaired, record impairment loss.
