Final Exam (Chapters 10-12) Flashcards
PP&E Characteristics
- Long-term in nature
- Acquired for use in operations not for resale
- Have physical substance
Reported at…
- Depreciated cost
- Land is an exception
Why is land not depreciated?
It does not lose its usefulness or value over time so no need to expense it
What does it mean to capitalize an asset?
- Put it on the balance sheet (and expense it over time)
- Otherwise, put it all on the income statement
Land
Only non-depreciable fixed asset
Cost of land includes:
- Purchase price
- Closing costs, attorney fees, etc.
- Cost of grading, filling, draining, and clearing (less salvage)
- Permanent land improvements (landscaping)
Land improvements
Account to classify temporary improvements (improvements with limited lives)
Equipment costs include:
- Purchase price
- Freight charges
- Assembly and installation costs
- Trial runs!
Capitalize interest when:
- Expenditures for the asset have been made
- Activities for readying the asset are in progress
- Interest costs are being incurred
Capitalize the lesser of:
- Actual interest costs
- Avoidable interest
- Pay out actual interest, capitalize lower, difference is interest expense
Avoidable interest
The interest that could have been avoided if expenditures for the asset had not been made
In general, companies should record PP&E at:
1) Fair value of what they give up or
2) Fair value of the asset received
Lump sum purchases
- Allocate total cost on basis of relative fair market values
- Use property tax assessments as indicators of relative market values
Issuance of stock
- Market value of stock issued is a good indication of the cost of the property acquired
- On the date of exchange, market not par value
Gain/loss on exchange of PP&E is computed by:
Comparing book value of the asset given up with the fair value of that same asset
When to recognize losses on all exchanges
IMMEDIATELY
When to recognize gains:
- If a gain and there is commercial substance, recognize the gain IMMEDIATELY
- If not then different
Commercial substance:
- Future cash flows change as a result of the transaction
- Example: trucks with different useful lives rather than just swapping colors
If no commercial substance and not 25% of fair value received is monetary then:
Recognize monetary portion of gain
-Total gain * (cash received/total FV received)
Costs subsequent to acquisition
- Costs incurred to achieve greater future benefits from the asset should be capitalized
- Costs that simply maintain given level of service should be expensed
For costs subsequent to be capitalized…
1) useful life of asset must be increased OR
2) The quantity of service produced from the asset must be increased OR
3) Quality of the units produced must be enhanced
Ordinary repairs should be…
Expensed in the period incurred
Disposition of Fixed Assets
1) Update depreciation to the date of disposition
2) Remove cost and accumulated depreciation from the books
3) Record any cash received
4) Recognize any gain or loss
Depreciation
- Cost allocation, not valuation
- Alllocation cost of tangible assets in a rational and systematic manner over the periods of use
If we did not depreciate fixed assets, how would it affect net income?
- Lowest in period you buy it, abnormally high after if expensed
- If capitalized, big loss at the end of the life of the asset
Tax depreciation
IRS required a certain method of depreciation so often the books will differ from tax forms because of this
Activity Method
- Assumes function of use not of time
- Life determined by output it provides (untis produced) or input measures (machine hours)
- (cost-salvage val)/Life in units * units of output during period
Straight-line method
- Most commonly-used, simple a constant amount is expensed each period
- Assumes that asset’s economic usefulness is the same each year
- (cost-salvage val)/useful life
Accelerated methods
If asset is more efficient in earlier years, then more depreciation should be charged in those years
Sum-Of-Years’-Digits Method
-Fraction remains the same each year
Number of years of useful life left at BEG of year/
Sum of digits from 1 tot he total years of useful life
Declining Balance Method
A constant rate is applied to the remaining book value (NOT depreciable base)
- Salvage value is ignored but cannot depreciate lower than salvage value
- 2(Straight-line Rate)(Book Value)
- SL rate is just 1/useful life
Accelerated depreciation vs. straight-line depreciation
Total is the same for every depreciation method because bigger charges earlier in the year are offset by smaller ones
When revised estimates, depreciation:
- Is re-calculated (based on these estimates)
- Changes in prior periods are not “Corrections of errors” and do not effects previous statements
Depletion
Used to account for natural resources that are depleted over a period of time
-Allocate cost of natural resources to the periods in which resources contribute to the revenue producing processes of the business
-Normally units of production method is used
(Cost-Salvage Value)/Estimated Recoverable Units
Included costs in depletion:
- Acquisition
- Exploration
- Intangible
- Development
- PV of Restoration
Acquisition cost
Purchase of property containing natural resources or the right to explore
Successful Efforts approach
Capitalize only exploration costs that result in producible reserves, all else expensed
Full Cost approach
- Capitalize all exploration costs whether successful or not
- All companies push the SEC to use, costs will be the same but evens them out
1970’s fight, FASB and SEC
Switch from successful efforts to full cost
Development costs
- Tangible equipment costs (equipment used to extract resource)
- If movable, decpreciate over useful life; if not moveable depreciate over the lesser of useful life or life of resource
Restoration costs
Present value of costs that will be used to restore the property to its natural state
Asset impairments
- Fixed assets not stated at fair value because assumption that company is not going to sell them
- If company does not plan to recover the carrying value (through use or disposing), asset must be impaired
- Only impair if there is something that makes us think that the asset is worth less than the amount on the books
3 steps for assets in use:
- Events indicate carrying value may not be recoverable (only through triggering events, based on expected future cash flows)
- Recoverability test: is book value > expected future net cash flows? Yes = impairment
- Impairment loss = book value - fair value (market value or PV of future cash flows)
- Cannot restore (write up) impairment losses
Intangible assets
- Lack physical substance
- Not financial instruments
Common types of intangibles:
- Patents (20 years)
- Copyright (life of creator + 70 yrs) - music, art, movies
- Trademarks (indefinite number of 10-year renewals)
- Franchises or licenses
- Goodwill (indefinite)
Internally created intangibles
- Generally expensed
- Capitalize only direct costs (ie, successful legal costs)
Purchased intangibles
- Capitalize, record at cost
- Include all costs necessary to make intangible ready for current use
is R&D intangible asset?
No, does not meet FASB threshold for probable future economic benefit
Limited-life Intangibles
- Amortize over shorter of legal life or useful life
- Amortization base is (cost - residual) - usually 0
- Credit asset account or acc. amortization
Indefinite-life intangibles
No foreseeable limit, no amortization
-Trademarks are considered to be indefinite - do not amortize
Goodwill
- Most intangible of all assets, cannot sell
- Occurs when market value of purchased company is greater than the value of net assets
- indefinite life, not amortized
- Record at FV of what it is worth on day of purchase
Impairment of indefinite
- Should be tested for impairment at least annually
- Recoverability test not used, fair value test
- If fair value is less than carrying amount, difference is the impairment
Impairment of Goodwill
- If FV of unit is less than CV of all net assets (including goodwill), then impaired
- Equal to difference in implied value and CV of goodwill
- implied value = difference in FV of unit and FV of fixed assets
- Do all depreciation, amortizations, and other impairments before goodwill
5 Steps for Revenue Recognition
1) Identify the contract with customers
2) Identify the separate performance obligations in the contract
3) Determine the transaction price
4) Allocate the transaction price to the separate performance obligations
5) Recognize revenue when each performance obligation is satisfied
