Chapter 8 Terms Flashcards
expenditure
cash disbursement
How do you acquire a non-current asset?
What are the various costs involved?
Capital expenditure results in the acquisition of a non-current asset, including any additional costs involved in preparing the asset for its intended use.
You do not need to memorize the following, just read it:
Land:
Acquire
-purchase price
- commission to real estate agent
- legal fees
Prepare
- draining
- clearing
- landscaping
- demolition
- assessments for streets and sewage system
Building:
Acquire
- purchase price
- commission to real estate agent
- legal fees
Prepare
- remodelling costs before use
- payments to tenants for premature termination of lease
Equipment:
Acquire
- invoice cost
- transportation
- insurance during transportation
Prepare
- installation including wages
- special floor foundations or supports
- wiring
- inspection
- test run costs
Revenue expenditure vs. capital expenditure
capital expenditure is the cost to get PPE into operation, and is expected to have future benefit for more than one year
revenue expenditure is the cost to make revenue, and does not have a future benefit beyond one year, or has future benefit beyond the year but the cost of it is so low that it is expensed this way (rather than depreciating)
They are very similar and it comes down to a matter of judgement to categorize them, so ask these questions when deciding to expense or add to the depreciable amount:
- Will it benefit more than one accounting period?
- Will it enhance the service potential of the asset, or make it more valuable or more adaptable?
- Is the dollar amount material?
If it does not meet all three criteria then it is a revenue expenditure and it is expensed.
capitalization policy limit
determined by the company
the upper limit beyond which you can no longer expense something and you have to go the depreciation route
During installation, a component broken because it was carelessly left on the floor. Does this count towards the cost of the machinery?
No, because this could have been prevented. This is not going to affect the accounting for the PPE. It will affect an expense account instead.
Does depreciation continue even if the asset becomes idle or is retired from use?
Yes; continue to depreciate until the value of the accumulated depreciation matches so that it is zeroed out, called “fully depreciated”. This is an application of the matching principle.
residual value
the estimated worth of the asset at the end of its estimated useful life
useful life
The length of time that a long-lived asset is estimated to be of benefit to the CURRENT OWNER.
productive output
the amount of goods or services expected to be provided (units of production could be hours used, units of output, kilometres driven)
Units-of-Production Method and equation to find depreciation per unit
Also known as “Usage-Based Depreciation Method”
Used when the output of an asset varies from period to period.
Used when the earning of revenues depends on the amount of output.
(cost - residual value)/ estimated units of output = depreciation per unit
This one will feel like the straight-line method but it is just dividing by estimated units of output, and then multiplying this full thing by the amount of units used
BUT it is so much easier to think of it this way:
depreciation for that year = (cost - residual value)(proportion of units used that year compared to the useful life units)
so 19 units used / 200 units that can be used would give you that proportion
carrying amount or net book value
carrying amount = cost - accumulated depreciation
(residual value is NOT used to adjust this carrying amount even if there is a better known residual amount now that a few years have passed; residual value is only used to calculate the depreciation expense and should be the same as when it was first decided in an ideal world.)
The carrying amount CANNOT be less than the residual amount. There is a maximum allowable accumulated depreciation.
Accelerated Time-Based Depreciation Method
also known as Double-Declining Balance (DDB)
depreciation for that year = (carrying amount)(2) / estimated total useful life
The carrying amount does not include a subtraction of the residual value!!! Carrying amount = cost - accumulated depreciation (not cost - residual!!!!)
YOU MUST REMEMBER to subtract the accumulated depreciation from the cost to get that top number.
The estimated total useful life should be constant for each year. It is rare that this figure would change.
This is always twice the rate of depreciation using the straight-line method. So 15% would become 30% for example as the rate of depreciation. So the rate has this relationship, but the rest of the equation does not!!!
Straight line would be
depreciation for that year = cost - residual / estimated total useful life
So make sure that you understand the difference!
How do you approximate partial years when calculating depreciation?
They taught two methods:
You can round to the nearest whole months where you had the asset working for you.
You can assume that you had it for 0.5 years for the partial years regardless of when it was bought or sold.
When you revise depreciation what do you have to remember?
Make sure that you are using the new amount of years left, even if they give you a new amount that includes the total years. So if 3 years have passed, and they say the revised useful life will be 9 years, you would use 6 years because that is the time that has not passed yet.
however, if there is no revision, you will continue to use the 6 years every year in subsequent calculations!!! I see this as a potential chasm that you will fall into!
Also, use the new amount of value that it has instead of the original purchase price to make the calculation, even with straight-line depreciation where you would usually not look at the carrying amount!
So cost - accumulated depreciation will give you the new cost (at least that is what was done with the straight-line method)
componentization
Each MAJOR component that has a different estimated useful life than the rest of an asset must be recorded and depreciated separately. This is the process that categorizes the parts by the components of the whole.
Given this scenario how would you proceed? What is the loss going to be?
20000 loss is debited to make the accounts balance
Basically the original purchase price was
What are the calculations necessary to answer this full question?
Wipe out the old accumulated depreciation and asset. Make sure to record the expense due to not selling it for what it was worth in your books. Record the amount of cash received.
Add assets the way you usually do.
Record depreciation the way you usually do.
Keep in mind that the first two entries in this image are usually combined together, so that is why it looks slightly different. In addition, the cash comes in, and then the accounts payable is created, instead of having those combined, so that also makes it look different. Everything is what you are used to otherwise.
recoverable amount
the fair value of the asset at the time less any estimated costs to sell it
impairment loss
A loss that must be recorded when the recoverable amount is lower than the carrying amount
Remember that the carrying amount is also known as the net book value, and means cost less accumulated depreciation.
Recoverable amount is what you can get for it minus what it takes to sell it.
Their examples are:
technological obsolescence
economic downturn
physical disaster
When an impairment is recorded, subsequent years’ depreciation expense must also be revised. The carrying amount will be revised!
How do you calculate revised depreciation with the unit-based method?
revised depreciation = (recoverable amount - residual value)(units used this year / units left to use)
This is almost the same as before when you didn’t have a revised amount but you were doing unit-based method of depreciation:
depreciation = (cost - residual value)(units used this year / units expected to use over the useful life)
The only change is that you have to look at what the new cost is because it lost value on the market and thus we reported an impairment loss. This means that the full equation needs to be redone to ensure that we are looking at the new amounts of units that are expected to be used from here on, rather than those original values.
You’ll be able to do these questions much more easily if you write the equations on paper rather than trying to input them into one box, since they get complicated and they are hard to memorize all together.
Recognize that you have an impairment loss and realize that this will change your depreciation calculation, then follow these steps:
Step 1: calculate the units used that year
Step 2: calculate the units left to use
Step 3: calculate the revised depreciation
How do you know if you have a loss or gain on disposal or loss or gain on sale?
Compare the carrying amount to what you are being paid for it.
If carrying amount > cash received then you have a loss on disposal and thus must debit loss on disposal for the difference
If carrying amount < cash received (or proceeds received) then you have a gain on disposal and thus must credit gain on disposal for the difference
loss on disposal works like an expense
gain on disposal works like revenue
So to report loss on disposal you will debit, just like you debit other expense accounts to show their expense occurring
And to report gain on disposal you will credit, just like you would a revenue account
How do you calculate the cost of the new asset given the old carrying amount of a trade-in, the cash paid for the new equipment, and the loss suffered because of the difference of trade-in allowance vs. fair value of the old asset? First state how to calculate the loss suffered, then do the calculation of the new asset cost (not the same as the cash paid for it!)
Loss on disposal comes from looking at the original cost of the old asset, subtracting its accumulated depreciation, and subtracting its fair value.
loss on disposal = carrying amount of old asset - fair value
Fair value is what is getting offered for the asset so it could be 2000
Carrying amount of old asset could be 5000
So loss on disposal would be 3000.
So Fair value is really unfair!
(previously you calculated loss on disposal by looking at the cash instead, so that meant that you just had to balance out the entry in the picture because they told you what cash was given to you, but now they are teaching you to calculate the loss on disposal by looking at the fair value instead of by looking at the cash coming in)
Then use the loss on disposal as a debit since it is an expense.
Then proceed to calculate the cost of the new asset (this is not the same as the cash given in for the asset!). You will already be given the cash paid for the new asset in the problem.
carrying amount of old asset + cash paid for the new asset - loss on disposal = cost of the new asset
Just make sure that if you see retail value in a question not to use it. You need to use the fair value of the asset in this equation if you see fair value listed:
loss on disposal = carrying amount of old asset - fair value
Then use that to make any calculations necessary to fill in the rest of the accounts. You may find that the new asset coming in will have a relationship to the retail value, but that the loss or gain on disposal changes this new asset’s cost in the books. So compute loss or gain on disposal if they give you fair value in the question.
What are the account names required for this entry?
How do you perform the calculations and in what order?
First calculate loss on disposal. loss = carrying amount - fair value
Carrying amount and fair value are both supplied in the question.
Then calculate the cost of the new asset (not the cash paid, as that is given in the question and they are not the same thing) using the following equation, subbing in values for carrying amount, cost of new asset, and loss as calculated earlier. If it is a gain, then just use a negative value or place it on the other side. You will not use the retail value at all in any of your calculations.
cash + carrying amount = cost of new asset + loss
(THINK CA CA = LOST COST) where cash is the amount of money being handed over in that transaction for the new asset, and the cost is for the new asset. If you forget this equation don’t worry since it is just to calculate the last account on the entry so you can just balance debits and credits and you don’t even need to use this equation.
Remember that you may have a loss or a gain, and that is determined by a positive or negative value in your calculations. The important thing here is to compare the carrying value to the fair value to logically determine if it is a loss or a gain. If the fair value is less than the carrying value, it would of course be a loss because it is not actually worth as much as our accounting records state. In this case we got a negative answer, so it became a positive gain on disposal
It is interesting to note the “retail value” what this really is. The 12500 retail value can be calculated in two different ways and it works out. Here is one way:
retail value = new equipment asset amount to be recorded in the books + gain on disposal
or
retail value = cost of new asset + gain on disposal
So be careful to not use the retail value as the cost of new asset (known here as new equipment cost) because they are not the same; they differ by the loss or gain on disposal, and that is important to note.
Year-end Journal Entry to record a patent amortization worth $20,000 that will last 40 years with no residual value
Debit amortization expense - patent 500 from (20000-0)/40 assuming you had the patent the whole year, multiply by the proportion of months otherwise to get partial years. For example 4/12 would get you the last four months in the year’s amortization.
Credit Accumulated Amortization - Patent 500
You may also need to account for impairment loss, gains, loss on disposal of intangible assets and these are calculated and recorded in the same manner as for property, plant, and equipment.
Image is a different one, but just to show that you need to account for 10 months in that one.
Journal entry to record purchase and amortization expense of a trademark
debit trademark
credit cash
When year-end comes
debit amortization expense - trademark
credit accumulated amortization - trademark
Notice that you need to pay attention to how long they intend to use the trademark and not its legal life. In the picture they are using 63 not 75 years.
This is a trade-in question
First do the calculations in blue, then balance the two sides to get the calculation in black
You need to memorize that loss on disposal = carrying amount - fair value
Here that calculation was positive, so you have a loss.
Keep in mind that sometimes this will be a negative result and thus you will have a gain.
Instead of balancing out debits and credits you can also use this equation you already have memorized:
carrying amount + cash = loss + cost
