Chapter 9

Question 1

Plant Assets

Answer 1

PPE, PE, fixed assets
They are resources that have three characteristics:
–> They have a physical substance (a definite shape and size)
–> They are used in the operations of a business
–> They aren’t intended for sale to customers

Except for land, plant assets decline in service potential over their useful lives
They are expected to be of use to the company for a number of years

Question 2

Cost of plant assets

Answer 2

Consists of all expenditures necessary to acquire the asset and make it ready for its intended use

Question 3

Land

Answer 3

usually used as a site for a manufacturing plant or office building. It isn’t amortised

Its cost includes:
–> The cash purchase price
–> The closing costs such as title and attorney’s fees
–> Real estate broker’s commission
–> Accrued property taxes
–> Cost of making it ready for use

Debit land
Credit cash / accounts payable

Question 4

Land improvements

Answer 4

Structural additions with limited lives that are made to land
–> Their cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use
–> Their costs are depreciated over their useful life

Question 5

Buildings

Answer 5

Facilities used in operation
Companies debit to the buildings account all necessary expenditures related to the purchase or construction of a building

When a building is purchased, such costs include:
–> Purchase cost
–> Closing costs (attorney)
–> Broker’s fee
–> Cost to make the building ready to use

When a building is constructed, its cost include:
–> Contract price
–> Payments for architect’s fees
–> Building permits
–> Excavation costs

Interest costs are also included, but it is limited to interest costs incurred during the construction period

Question 6

Equipment

Answer 6

Includes assets used in operations

They costs include:
–> Purchase price
–> Sales taxes
–> Freight charges
–> Insurance during transit paid by the purchaser
–> Also include any cost that will benefit future periods - which are labelled as expenses

Question 7

Expenditures during useful life

Answer 7

During the useful life of a plant asset, a company may incur costs for ordinary repairs, additions or improvements

Question 8

Ordinary repairs

Answer 8

expenditures to maintain the operating efficiency and productive life of the unit - they are usually small amounts that occur frequently
Often referred to as revenue expenditures

Question 9

Additions and improvements

Answer 9

costs incurred to increase the operating efficiency, productive capacity or useful life of a plant asset - they are usually material in amount and occur infrequently
Often referred to as capital expenditures

Question 10

Materiality

Answer 10

refers to the impact of an item’s size on a company’s financial operations
For this concept, some items are “negligible”
If a purchase doesn’t influence a business’ decision, they don’t have to follow IFRS in reporting that item

Question 11

Depreciation

Answer 11

It’s the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner

Question 12

Book vs Fair Value

Answer 12

Book: cost accumulated depreciation
Fair: actual value of the asset

The book value of a plant asset may be quite different from its fair value

Question 13

Obsolescence

Answer 13

The process of becoming out of date before the asset physically wears out
It doesn’t apply to land because its usefulness generally remains intact

Question 14

Going concern assumption

Answer 14

states that the business will remain in operation for the foreseeable future

Question 15

Recognising depreciation on an asset doesn’t result in an accumulation of cash for replacement of the asset

Answer 15

The balance in Accumulated Depreciation represents the total amount of the asset’s cost that the company has charged to expense.
It is not a cash fund.

Question 16

Factors in computing depreciation

Answer 16

Cost: all expenditures necessary to acquire the asset and make it ready for intended use
Useful Life: estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence
Residual value: estimate of the assets value at the end of its useful life

Question 17

Depreciable cost formula

Answer 17

Cost of the asset - Residual value

Question 18

Strait line depreciation method

Answer 18

Companies expense the same amount for each year of the asset’s useful life - it is measured by the passage of time

The first step it co compute depreciable cost
Then we compute the annual depreciation expense
We must consider for how many months we used the asset

Depreciable cost: Cost - Residual value

Annual depreciation expense: Depreciable cost / Useful life

Question 19

Units of activity depreciation method

Answer 19

Companies depreciate an amount based on units produced by that asset

The first step is to compute total units of activity and then the depreciable costs per unit
Then we calculate the annual depreciation expense

Depreciable cost per unit: Depreciable cost / Total units of activity

Annual Depreciation expense: Depreciable cost per unit x Units of Activity during the year

Question 20

Declining balance depreciation method

Answer 20

companies depreciate an asset based on its declining book value
The depreciation rate remains the same throughout the year but the book value changes over the years
This method ignores residual value
This method produces higher depreciation costs in the first years

Annual depreciation expense: book value at the beginning of the year x declining balance rate

Question 21

Component depreciation

Answer 21

When a plant asset has parts with significantly useful lives they must be depreciated separately

Question 22

Depreciation and income taxes

Answer 22

Tax laws allow company taxpayers to deduct depreciation expenses when they compute taxable income. However, tax laws often do not require taxpayers to use the same depreciation method on the tax return that is used in preparing financial statements.

Many companies use straight-line in their financial statements to maximise net income. At the same time, they use an accelerated-depreciation method on their tax returns to minimise their income taxes.

Question 23

Gain situation in a revaluation of plant assets

Answer 23

Accumulated depreciation is eliminated
Depreciation - Revaluation surplus is credited to equipment and so is done to the revaluation surplus

Reported in other comprehensive income

Question 24

Loss situation in a revaluation of plant assets

Answer 24

Accumulated depreciation is eliminated
An impairment loss account is debited
This way the loss and depreciation is credited from the asset account

Reported in net income

Question 25

Revising Periodic Depreciation

Answer 25

Depreciation is often revised and if a change or adjustment must be made, it is made in the current and future yeats
It doesn’t change depreciation in prior periods

Question 26

Retirement of plant assets

Answer 26

Arrived at the end of its useful life the asset is retired

What asset is still useful to the company?
–> The asset and its accumulated depreciation will still be reported on the statement of financial position
–> But without further depreciation adjustment

What if the asset is retired before the end of its useful life?
–> A loss on disposal occurs

Question 27

Sale of Plant Assets

Answer 27

In this case the book value is compared to the cash received in the sale

Gain on disposal: if the proceeds of the sale exceed the book value of the plant asset
Loss on disposal: if the proceeds of the sale are less than the book value of the plant asset

Gain on sale: price of asset sold > book value
Loss on sale: price of asset sold < book value

Question 28

Natural resources

Answer 28

Standing timber and resources extracted from the ground
Companies generally use the units-of-activity method to compute depletion
The reason is that depletion generally is a function of the units extracted during the year

Question 29

Depletion

Answer 29

The process of allocating the cost of natural resources
To compute depletion the cost per unit is then multiplied by the number of units extracted

Question 30

Depletion cost per unit Formula

Answer 30

(Total Cost - Residual Value) / Total Estimated Units Available

Question 31

Intangible assets

Answer 31

Rights, privileges and competitive advantages that result from the ownership of long lived assets that don’t possess physical substance

They may arise from:
–> Government grants, such as subsidies, bonds…
–> Acquisition of another business, in which the purchase price includes a payment for goodwill
–> Private monopolistic arrangements arising from contractual agreements

Their cost must be amortised

Question 32

Amortisation

Answer 32

Allocation of cost to useful life
Companies amortise the cost of a patent over its 20 year life or its useful life, whichever is shorter
Amortisation expense is considered an operating expense

Question 33

Patent

Answer 33

An exclusive right issued by a patent office that enables the recipient to manufacture, sell, or otherwise control and invention for a specific number of years from the due of the grant

It is non renewable

The initial cost of a patent is the cash or cash equivalent price paid to acquire the pate

The owner adds those costs to the Patents account and amortises them over the remaining life of the patent.

The patent holder amortises the cost of a patent over its legal life or its useful life, whichever is shorter.

Question 34

Copyrights

Answer 34

Give the owner the exclusive right to reproduce and sell an artistic or published work

Copyrights extend for the life of the creator plus a specified number of years, which can vary by country but is commonly 70 years

The cost of a copyright is the cost of acquiring and defending it.

The useful life of a copyright generally is significantly shorter than its legal life.
Therefore, copyrights usually are amortised over a relatively short period of time.

Question 35

Trademarks and names

Answer 35

word, phrase, symbol that identifies a particular enterprise/product

Their cost is the acquisition cost - they don’t get amortised, they have indefinite lives

Question 36

Franchises and Licences

Answer 36

Their cost is any cost connected to their purchase and their acquisition

Franchise: a contractual agreement between a franchisor and a franchisee
–> The franchisor grants the franchisee the right to sell certain products, perform specific services or use certain trademarks or names

Licences: legal permissions granted by a government or organisation that allow a person or business to perform a specific activity or use a specific asset

When a company incurs costs in connection with the purchase of a franchise or licence, it should recognise an intangible asset.

Companies should amortise the cost of a limited-life franchise (or licence) over its useful life. If the life is indefinite, the cost is not amortised.

Annual payments made under a franchise agreement are recorded as operating expenses in the period in which they are incurred.

Question 37

Goodwill

Answer 37

Represents the value of all favourable attributes that relate to a company that isn’t tied to any other specific asset

It can be identified with the business as a whole

Companies record goodwill only when an entire business is purchased. In that case, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.

Goodwill is not amortised because it is considered to have an indefinite life.

Question 38

Research and development costs

Answer 38

Expenditures that may lead to patents, copyrights, new processes and new products

Question 39

Asset Turnover

Answer 39

Net Sales / Average Total Assets