Chapter 9 Flashcards
plant assets
Resources that have physical substance (a definite size and shape), are used in operationso fa business, and are not intended for sale to customers
AKA PPE, and fixed assets
Expected to provide service to the company for a number of years
Decline in service potential over useful lives (except for land)
Cost principle
Requires that companies record plant assets at cost
*Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use
Example: cost of factory machinery
Purchase price
Freight costs by purchaser
installation costs
Revenue expenditures
Expenditures that are immediately charged against revenues as an expense
Capital expenditures
Expenditures that increase the company’s investment in plant assets
Cost is measured by:
cash paid in a cash transaction or by the cash equivalent price paid when companies use noncash assets in payments
Cash equivalent price
The fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable
IFRS: asset valuation
IFRS is flexible regarding asset valuation
Companies revalue to fair value when they believe this information is more relevant
Land improvements
Structural additions made to land, such as driveways, parking lots, fences, landscaping, and underground sprinklers
lease
a contractual agreement in which the owner of an asset allows another party to use the asset for a period of time at an agreed price
Lessor
The owner of the asset
lesse
the other party who uses the asset for a period of time at an agreed price
Operating leases
Allow the lesse to account for the transaction as a rental, with neither an asset nor a liability recorded
Capital lease
Lesses show up both the asset and the liability on the balance sheet
Advantages of leasing an asset versus purchasing:
- Reduced risk of obsolescence
- Little or no down payment
- Shared tax advantages
- Assets and liability not reported
Depreciation
The process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner
*cost allocation designed to properly match expenses with revenues*
Book value
Cost less accumulated depreciation
Depreciation applies to three classes of plant assets:
Land improvements
Buildings
Equipment
Depreciable asset
The usefulness to the company and the revenue-producing ability of each class decline over the asset’s useful life
Depreciation does not apply to land
Because its usefulness and revenue-producing ability generally remain intact as long as the land is owned
*in fact, uusefulness of land can increase because of scarcity of good sites
Land is NOT a depreciable asset
Obsolescence
The process by which an asset becomes out of date before it physically wears out
Factors in computing depreciation
- Cost
- Useful life
- Salvange value
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 vulnerabliity to obsolescence
Salvage value
Estimate of the asset’s value at the end of its useful life
Helpful hint: depreciation
Depreciation expense reported on income statement
Accumulated depreciation is reported on the balance sheet as a deduction from plant assets
Depreciation methods
- Straight-line
- Declining-balance
- Units-of-activity
Straight-line method
A method in which companies expense an equal amount of depreciation for each year of the asset’s useful life
*used for 95% of U.S. companies
Depreciable cost
The total amount subject to depreciation
Cost of the plant asset less its salvage value
Declining balance method
A depreciation method that applies a constant rate to the declining book value of the asset and produces a decreasing annual depreciation epxnse over the asset’s useful life
accelerated-depreciation method
A depreciation method that produces higher depreciation expense in the early years than the straight-line approach
double-declining balance method
Applying the declining-balance approach at different rates, which results in varying speeds of depreciation
Units-of-activity method
A depreciation method in which useful life is expressed in terms of the total units of production or use expected from the asset
Uses for units-of-activity:
Factory machinery
Delivery equipment (miles drive, hours in use)
Depreciation expense
Cost - Salvage value
Useful life
Large corporations use:
Straight-line depreciation in their financial statements in order to maximize net income
Use aspecial accelerated depreciation method on their tax returns in order to minimize their incomee taxes
Special accelerated-depreciation method
Modified accelerated cost recovery system
Revising periodic depreciation in current and future years but not to prior periods
Company does not correct previously recorded depreciation expense
Revises depreciation expense for current and future years
*rationale = to not adversely affect users’ confidence in financial statements
Extending an asset’s estimated life…….
reduces depreciation expense and increases current period income
Ordinary repairs
Expenditures to maintain the operating efficiency and expected productive life of the unit
ex. tune ups, oil changes, painting,
Debited to maintenance and repairs expense as incurred
Additions and improvements
Costs incurred to increase the operating efficiency, productive capacity, or expected useful life of a plant asset
Debitted to plant asset affected
capital expenditures
impairment
a permanent deccline in the fair value of an asset
Eliminating book value
Debit accumulated depreciation
Credit asset account for the cost of the asset
Methods of plant asset disposal
Sale - equipment sold to another party
Retirement - equipment is scrapped or discarded
Exchange - exisitng equipment is traded for new equipment
Gain on disposal
If the proceeds from the sale exceed the book value of the plant asset
Loss on disposal
if the proceeds from the sale are less than the book value of the plant asset sold
Journal entry for retirement of plant assets
Debit Accmulated depreciation
Credit asset account for original of the asset
gain is not possible
loss = asset’s book value on the date of retirement
Return on assets ratio
Indicates amount of net income generated by each dollar of assets
Net Income
Average Total Assets
Marketing ROI (return on investment)
Profit generated by a marketing intivative divided by the investment in that initiative
Asset turnover ratio
Indicates how efficiently a company uses its assets to generate sales
Net Sales
Average Total Assets
Return on assets =
Profit margin x Asset turnover
Net income
Average Total Assets
Intangible assets
Rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance
ex. ipod, nike swoosh
intangible with limited life
Company allocates its cost over the asset’s useful life using amortization
Amortization
The process of allocating to expense the cost of an intangible asset
Journal entry for amortization of intangible asset
Amortization expense XXX
Intangible asset XXX
Patent
An exclusive right issued by the U.S. patent office that enables the receipient to manufacture, sell, or otherwise control an inventrion for a 20 year period from the date of the grant
Research and development costs
Expenditures that may lead to patents, copyrights, new processes, and new products
seen as an expense when incurred
Copyrights
Give the owner the exclusive right to reproduce and sell an artistic or published work
lasts for life of creator plus 70 years
consists of cost of acquiring and defending it
Trademark or trade name
A word, phrase, jingle, or symbol that distinguishes or identifies a particular enterprise or pdouct
ex. Wheaties, Coca-Cola, Jeep
Franchise
A contractural arrangement under which the franchisor grants the franchisee the right to sell certain products, to provide specific services, or to use certain trademarks or trade names, usually within a designated geographic area
Liscences
Operating rights to use public property, granted by a governmental agency to a business
Goodwill
The value of all favorable attributes that relate to a company that are not attributable to any other specifi casset
When do companies record goodwill?
Only when there is an exchange transaction that involves the purchase of an entire business
Goodwill is the excess of cost over the fair value of the net assets acquired
Costs of Land
Cash purchase price
Closing costs such as title and attorney’s fees
Real estate brokers’ commissions
Accrued property taxes
Clearing, draining, filling, and grading
Demolition and removal costs
- Proceeds from salvage value
Land improvements costs: parking lot
paving, fencing, and lighting
What does Debt to Total Assets show?
Measures the amount of financing by creditors instead of stockholders
The higher, the riskier
Building Costs when constructed
Contract price
architects’ fees
building permits
excavation costs
interest costs during construction
Equipment costs
Cash purchase price
sales taxes
freight charges
insurance during transit paid by the purchaser
assembling, installing, and testing the unit
Not included = motor vehicle licences, and accident insurance
What does Times interest earned ratio show?
Provides an indication of a company’s ability to meet interest payments as they come due
Building costs when purchased
Purchase price
Closing costs (attorney fees, title insurance)
Real estate broker’s commission
Remodeling rooms and offices, etc
Why would a company retire bonds before maturity?
A company may decide to retire bonds before maturity to reduce interest cost and remove debt from its balance sheet. A company will retire debt early only if it has sufficient cash resources.
What are the steps to retire a bond before maturity?
When bonds are retired before maturity, it is necessary to eliminate the carrying value of the bonds at the redemption date and recognize a gain or loss on redemption. The gain or loss is the difference between the cash paid and the carrying value of the bonds.
Journal entry to correct error in deposit
A/R XXX
Cash XXX
Journal entry to correct error in recording check
A/P XXX
Cash XXX
