Chapter 9 (Week 5) Flashcards
Plant Assets
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
Cost of plant assets
Consists of all expenditures necessary to acquire the asset and make it ready for its intended use
Land
usually used as a site for a manufacturing plant or office building.
It isn’t amortised
Land improvements
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
Buildings
Facilities used in operation
Equipment
Includes assets used in operations
Expenditures during useful life
During the useful life of a plant asset, a company may incur costs for ordinary repairs, additions or improvements
Ordinary repairs
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
Additions and improvements
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
Materiality
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
Depreciation
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
Book vs Fair Value
Book: cost - accumulated depreciation
Fair: actual value of the asset
Obsolescence
The process of becoming out of date before the asset physically wears out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
Factors in computing depreciation
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
Depreciable cost formula
Cost of the asset - Residual value
Straight line depreciation method
Companies expense the same amount for each year of the asset’s useful life - it is measured by the passage of time
Depreciable cost: Cost - Residual value
Annual depreciation expense: Depreciable cost / Useful life
- Best for assets that generate revenue evenly
Units of activity depreciation method
Companies depreciate an amount based on units produced by that asset
Depreciable cost per unit: Depreciable cost / Total units of activity
Annual Depreciation expense: Depreciable cost per unit x Units of Activity during the year
- Best for assets that wear out because of use
Declining balance depreciation method
Companies depreciate an asset based on its declining book value
Annual depreciation expense: book value at the beginning of the year x declining balance rate
- Best for assets that generate revenue early in useful life
Component depreciation
When a plant asset has parts with significantly useful lives they must be depreciated separately
Depreciation and income taxes
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.
Revaluation of plant assets gain
If Fair Value > Book Value:
Revaluation of plant assets loss
If Fair Value < Book Value
Retirement of plant assets
Arrived at the end of its useful life the asset is retired
What asset is still useful to the company?
Loss on disposal
The asset is retired before the end of its useful life
Book value > Proceeds form Sale
Gain or Loss on Disposal
ProceedsfromSale − BookValueoftheAsset
Gain on disposal
Proceeds from sale > Book value
Sale of Plant Assets
In this case the book value is compared to the cash received in the sale
Gain on sale: price of asset sold > book value
Loss on sale: price of asset sold < book value
Natural resources
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
Depletion
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
Depletion cost per unit Formula
(Total Cost - Residual Value) / Total Estimated Units Available
Intangible assets
Rights, privileges and competitive advantages that result from the ownership of long lived assets that don’t possess physical substance
Their cost must be amortised
Amortisation
Allocation of cost to useful life
Amortisation expense is considered an operating expense
Patent
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
Copyrights
Give the owner the exclusive right to reproduce and sell an artistic or published work
Trademarks and names
word, phrase, symbol that identifies a particular enterprise/product
Their cost is the acquisition cost - they don’t get amortised, they have indefinite lives
Franchises and Licences
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
Goodwill
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.
Asset Turnover
Net Sales / Average Total Assets
