Chapter 7: Reporting and Interpreting Long Lived Assets Flashcards
What are long lived assets?
-Assets expected to provide economic beenfit to the reporting entity for a period greater than one year.
-Accountants use the term long-lived assets to identify property, plant, equipment, intangible assets, and goodwill.
What are the two types of long lived assets?
Tangible assets: Items with physical substance. Includes PPE, land, biological assets, natural resources, and buidlings, fixtures and equipment.
Intangible Assets: Items with property ownership rights but no physical substance. They frequently stem from intellectual property. Includes copyrights, patents, licences, trademarks, software, franchises, and subscription lists etc.
What is the formula for Fixed Asset Turnover Ratio? What does it measure
Fixed asset turnover ratio=Net sales(or operating revenues)/average net fixed assets.
or…
[Beginning + Ending balances of Property, plant, and equipment (net of accumulated depreciation)] ÷ 2
This formula measures how effectively it’s management is utilizing its property, plant, and equipment to generate revenues.
What is cost capitalization?
-Cost capitalization involves a company recording a cost as an asset on its balance sheet rather than immediately expensing it on the income statement. This happens if a firm consumes the asset in the process of generating revenues (e.g. a machine, or a patent), the firm should record an expense (allocate a portion of the cost)
-These capitalized costs are not immediately recognized as expenses but are allocated over the asset’s useful life through depreciation, amortization, depletion, or impairment.
-If not for cost capitalization, a company would record a big outflow of money for a short period at the beginning, and a small inflow in the period following that.
-In accounting we use the matching principle. That is what cost capitalization aligns with.
What do capitalized costs include?
-purchase price
-sales taxes
-legal fees
-transportation costs
-installation costs
Should interest costs be included as part of the cost of the asset when they are used for the cost of construction?
Interest costs during construction are considered capitalizable borrowing costs if they are directly attributable to the acquisition, construction, or production of a qualifying asset.
How do you calculate the true acquisition cost of something.
-First you take the invoice price, and then you deduct whatever discount was added. That will give you the “net cash invoice price”
-Then you add transportation charges, and you add preparation costs, which give you the true acquisition cost of the item.
On January 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? First try to understand what this question is asking you for.
-This question is asking me to assign a cost to the land and building when we are offered a bundled deal for accounting purposes.
-First we add up the value of both items for land and building which gives us our total of $315,000.
-Next we divide land by total value, and we divide building by total value. That gives us the percent of value for each item. 40% of the value comes from land, and 60% of the value comes from building.
-Then you take 40% of the $300,000 purchase fee for your assigned land cost.
-Next you take 60% of the $300,000 puchase for your assigned building cost.
-Finally, you make a journal entry. Debitting land for $120,000, debitting building for $180,000, and crediting cash for $300,000.
What gives you higher earnings, repairs, maintenance, or improvements?
-Ordinary repairs decrease shareholder’s equity through retained earnings
-On the other hand improvements are capitalized expenditures, which don’t effect net earnings.
-Therefore, you see higher net earnings when we do the improvements as opposed to the repairs or maintenance.
What is depreciation
-Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use.
-With depreciation we are allocating the cost over it’s useful life.
What is depreciation expense? Where does it go?
-It is the depreciation for the current year
-It goes on the statement of earnings
What is accumulated depreciation? Where does it go?
-It is the total depreciation to date on an asset.
-It goes into statement of earnings.
What type of assets do you depreciate?
-We depreciate tangible assets
-For the journal entry, debit depreciation expense, and credit accumulated depreciation
What type of assets do you amortize?
-We amortize intangible assets
-For the journal entry, debit amortization expense, and credit accumulated amortization
What is the carrying amount? How do we calculate it?
-The carrying amount is how much the asset is worth after the depreciation occurs.
-Acquisition cost-accumulated depreciation-write down=Carrying Cost
-Carrying amount should not equal market value.
What three calculations are required in the calculation of depreciation? What does that tell us about how we calculate depreciation?
1) Acquisition cost
2) Estimated useful life to the company
3) Estimated residual value
Two of these elements are estimates. Therefore, we calculate depreciation through estimate.
What are the three methods to calculate depreciation?
1) Straight-line
2) Units of production
3) Accelerated Method: Declining Balance
What is useful life in depreciation?
The expected service life of an asset to the present owner
What is residual value in depreciation?
The estimated amount to be recovered, less disposal costs at the end of estimated useful life of an asset
What is the formula to calculate depreciation with the straight-line method?
-The most commonly used method of depreciation. It’s also the simplest method.
-Depreciation expense per year=(cost-residual value)/useful life in years.
-Cost will be initial purchase cost
-Residual value will be how much it’s worth after we used it up.
-With straight line depreciation, the asset depreciates the same amount each year, and also depreciates the same amount regardless of usage.
What is the formula to calculate depreciation with the units of production (activity) method?
-First we calculate the depreciation rate using the formula below
-Depreciation Rate=(Cost-Residual Value)/Life in Units of Production
-Next we calculate the depreciation expense
-Depreciation Expense=Depreciation Rate*Number of Units Produced for the Year
-Number of units produced is more like number of units used
-With units of production method, depreciation is calculated based on the usage.
-Depreciation varies based on production level. Accordingly, depreciation is considered to be a “variable expense.”
How do we calculate depreciation using the declining balance method?
-The declining balance method assumes that more depreciation happens earlier on. It’s also called accelerated depreciation.
-As time goes on, depreciation expenses continue to decrease.
-Annual Depreciation Expense=Book Value @Beginning of the YearDecline Balance Rate(#of months/12)
-Single Declining Balance=Book Value1/Useful Life(#of months/12)
-Double Declining Balance=Book Value2/Useful Life(#of months/12)
-Carrying Amount=Cost-Accumulated depreciation
-With the declining balance method most of the depreciation happens early on, because as the years progress and the carrying value goes down, so does the multiple.
What is the formula for change in depreciation estimates?
-(Cost-Residual Value)*1/Useful Life=Original Depreciation Expense
Another way
-(Carrying Amount-New Residual Value)*1/Remaining Life=Revised Depreciation Expense
What does fixed asset turnover ratio measure? What is the formula for fixed asset turnover ratio?
-Fixed asset turnover ratio measures how much revenue a company generates from their PPE.
-Generally a higher fixed asset turnover ratio suggests effective management. An increasing ratio over time signals more efficient use of fixed assets.
-However, in very limited circumstances, a low fixed asset turnover ratio could be good as it would indicate the company is expanding rapidly. However, once again, if that number is absurdly low, they could be expanding too aggressively. Context is key.
-An increasing ratio could also signal that a firm cut back on capital expenditures, decreasing the denominator faster than the numerator, because they anticipate a downturn in business. That is a great example of when an increasing ratio is bad.
-Fixed Asset turnover ratio=Net sales(or operating revenues)/average net fixed assets
What is goodwill? When is it reported as an asset?
-Has no physical substance
-It reflects the favourable reputation that a company has with its customers
-Goodwill is only reported as an asset when one business purchases another business.
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What is an acquisition cost?
The acquisition cost is the net cash amount paid for the asset.
What is capitalized interest?
The amount of interest that is included in the cost of the construction.
When a basket purchase is made, why do we measure and record the cost of each asset seperately?
Because land is not depreciated, but buildings and equipment are. Land is not depreciated because it does not have a limited useful life. In addition, the valuation of land could go up or down.
Are annual maintenance costs included in the cost of equipment?
No annual maintenance costs aren’t included. This is because annual maintenance costs are not capitalized costs, they are operating expenses.
When calculating acquisition costs, do we calculate amounts paid by another party?
No
What is cost allocation?
Following the matching principle, we match the revenue earned in the period with the amount of the asset we used up to generate that revenue
What is estimated residual or salvage value?
Management’s estimate of the amount the company expects receive if they sell that asset.
When do we stop depreciating?
When residual value is reached. That applies to all three methods.
What journal entry do we prepare when there is a loss on the sale of equipment
Debit loss on sale of equipment(+E,-SE)
What are the steps to calculating depreciation when there is a change in it’s useful life, or it’s residual value, or both?
-Take acquisition cost, and subtract accumulated depreciation to get the carrying amount
-Subtract the new residual value. That will give you the new depreciable amount
-Take the new depreciable amount and divide it by remaining life to get annual depreciation using the straight line method.
How do you know if an expense should be made in the journal entry upon purchase of machinery?
You just have to ask the simple question: is it necessary to get the machine up and going.
Please note: Since the cleanup fees aren’t a necessary expense to run the machine, you don’t include it in the journal entry on purchase of the machinery.
