Property, Plant, and Equipment Flashcards
long-lived asset
tangible and intangible resources owned by a business and used in its operations over several years
tangible assets
land; buildings, fixtures, and equipment; natural
resources used in operations
intangible assets
patents, copyrights, franchises, licenses, and trademarks
Measuring acquisition of tangible long-lived assets
What expenditure be recorded as the cost of the asset? Examples?
These expenditures are ___
- All reasonable and necessary expenditures made in acquiring
and preparing an asset for use should be recorded as the cost
of the asset. - Sales tax
- Legal fees
- Transportation costs
- Installation cost
- These expenditures are capitalized (recorded as part of the total cost of the asset), not recorded as expenses in the current period
Acquisition Cost
Example: Southwest purchased a new 737 MAX 8 aircraft from Boeing on
January 1, 2020, for a list price of $122 million. Boeing offered Southwest
a discount of $4 million for signing the purchase agreement. In addition,
Southwest paid $400,000 to have the plan delivered and $1,600,000 to
prepare the new plane for use. What is the acquisition cost for this
aircraft?
$120,000,000
Invoice price $122,000,000
Less: Discount from Boeing (4,000,000)
Net cash invoice price 118,000,000
Add: Transportation charges paid by Southwest 400,000
Preparation costs paid by Southwest 1,600,000
Cost of the aircraft (added to the asset account) $120,000,000
A company may also construct an asset for its own use instead
of buying from a manufacturer
In this case, what does the cost of the asset include?
the cost of the asset includes all the necessary costs associated with construction.
* Labor, materials, interest incurred during the construction period.
* Capitalized interest: interest expense incurred during the construction of the asset.
Ordinary repairs and maintenance definition:
These expenses are ____ in nature, involve relative ____ amounts at each occurence, and _____ increase the productive life, operating efficiency, or capacity of the asset
These expenses are recurring in nature, involve relatively small
amounts at each occurrence, and DO NOT DIRECTLY increase the productive life, operating efficiency, or capacity of the asset
Improvements definition:
How do improvements differ from ordinary repairs and maintenance expenditure?
Improvements: expenditures that increase the productive life,
operating efficiency, or capacity of the asset
Improvements increase productive life while ORM do not directly increase productive life etc.
Southwest paid $1 billion for aircraft maintenance and repairs.
This amount was reported as an ____ on its _____
This amount was reported as an expense on its income
statement
Maintenance and repairs expense (+E, -SE)
Cash (-A)
Southwest spent $300 million to modify the exterior of its
aircraft to reduce fuel consumption, resulting in 9 percent greater fuel efficiency and lower operating costs.
These expenditures would have been recorded by Southwest, as
___:
capital expenditures
Flight equipment (+A)
Cash (-A)
In many cases, no clear line distinguishes improvements
(assets) from ordinary repairs and maintenance (expenses).
What happens here?
- Managers must exercise professional judgement and make a subjective decision.
- Auditors review the decision closely.
long-lived tangible asset: Depreciation
Depreciation is the process of allocating the cost of buildings
and equipment over their productive lives using a systematic and rational method
Depreciation is a
process of cost
allocation, not a process
of determining an
asset’s current market
value or worth
Depreciation Expense:
the amount of depreciation recorded during each period is reported on the income statement as Depreciation expense.
- Accumulated Depreciation:
the amount of depreciation expense
accumulated since the acquisition date is reported on the
balance sheet as a contra-asset account.
- Net book value:
acquisition cost of an asset – accumulated deprecation
To estimate depreciation expense, we need three pieces of information:
- Acquisition cost
- Estimated useful life to the company
- Estimated residual (or salvage) value at the end of the asset’s useful life to the company.
Estimated Useful Life
Estimated useful life represents management’s estimate of the
asset’s useful economic life to the company rather than its total economic life to all potential users
- Companies may have different estimated useful life for their
assets. - Differences in estimated lives and residual values of assets can have a significant impact on a comparison of the profitability of the competing companies.
Residual Value
- Residual value represents management’s estimate of the
amount the company expects to recover upon disposal of the
asset at the end of its estimated useful life. - Value of the asset as salvage or scrap or its expected value if sold to
another user.
3 Different Depreciation Methods
- Straight-line
- Units-of-production
- Declining-balance
Straight-Line Method
Under the straight-line method, an equal portion of an asset’s
depreciable cost is allocated to each accounting period over the
asset’s useful life.
- Depreciation expense is a constant amount each year.
- Accumulated depreciation increases by an equal amount each year.
- Net book value decreases by the same amount each year until it equals the estimated residual value.
Units-of-Production Method
Formula
The units-of-production depreciation method relates
depreciable cost to total estimated productive output
Formula: (Cost - Residual Value)/Estimated Total Prod * Actual Prod = Depreciation Expense
Is depreciation expense fixed or variable in the units-of-production method? Why?
In the units-of-production method, depreciation expense is a variable expense because it varies directly with production or use
What may be a drawback of the units-of-production method?
The units-of-production method is based on an estimate of an
asset’s total future productive capacity or output, which is
difficult to determine
Declining-Balance Method
Declining-balance method assigns more depreciation to early years and less depreciation to later years of an asset’s life.
- This method is used for assets that are considered to be more
efficient or productive when it is newer
Declining-Balance Method Formula
Double-Declining-Balance-Formula:
(Cost - Accumulated Depreciation) * 2/Useful Life = Depreciation Expense
accumulated depreciation increases over time
- Note that accumulated depreciation, not residual value, is included in the formula
Why is the declining-balance method often termed the double-declining-balance rate?
Declining-balance depreciation is based on applying a rate
exceeding the straight-line rate to the asset’s net book value
over time.
* The rate is often double (two times) the straight-line rate and is termed the double-declining-balance rate
Does the declining-balance method result in an increase or decline in depreciation expense over time? Why?
Because accumulated depreciation
increases each year, net book value
(cost minus accumulated depreciation)
decreases.
* The double declining rate is applied to
a lower net book value each year,
resulting in a decline in depreciation
expense over time
Declining-Balance Method: last year of the asset’s estimated useful life
More likely, in the last year
of the asset’s estimated
useful life, whatever
amount is needed to bring
net book value to residual
value is recorded,
regardless of the amount
of the computation.
- Assume there are two companies that
are exactly the same except that one
uses accelerated depreciation and the
other uses the straight-line method. - Which company will report a higher net
income? - Which company will have a higher total
depreciation expense by the end of the
asset’s life?
- The accelerated methods report higher
depreciation expense and lower net
income during the early years. - However, total depreciation expense by
the end of the asset’s life is the same.
Disposal of a depreciable asset usually requires two journal
entries:
- An entry to update the depreciation expense and accumulated
depreciation accounts. - An entry to record the disposal.
* The cost of the asset and any accumulated depreciation at the date of disposal
must be removed from the accounts.
* The difference between any resources received on the disposal of an asset and
its net book value on the date of disposal is treated as gain or loss on the
disposal of the asset
Example: at the end of year 17, Southwest sold an aircraft that
was no longer needed. The aircraft was sold for $11 million
cash. The $30 million original cost was depreciated using the
straight-line method over 25 years with no residual value. The last accounting for depreciation was at the end of Year 16.
Record the related journal entries
- Depreciation Expense Update for Year 17
Depreciation expense (+E, -SE) 1.2
Accumulated depreciation (+XA, -A) 1.2
- Entry that records sale
Cash (+A) 11
Accumulated depreciation (-XA, +A) 20.4
Flight Equipment (-A) 30
Gain on sale of assets (+R, +SE) 1.4
Intangible Asset examples
Most common intangible assets:
* Goodwill
* Trademarks
* Copyrights
* Technology
* Patents
* Franchises
* Licenses and operating rights
When are intangible assets recorded at historical cost?
only if they have been purchased
When are intangible assets expensed?
if they are developed internally by the company
Amortization of intangible assets
Amortization: the cost of an intangible asset with a definite life
is allocated on a straight-line basis each period over its useful
life.
* Amortization is similar to depreciation
Most companies assume no residual value for their intangible assets.
How are intangible assets reported on the balance sheet?
Intangible assets are reported at cost less accumulated
amortization on the balance sheet.
Example: a company purchases a patent for $800,000 and
intend to use it for 20 years. What is the adjusting entry to
record the amortization expense?
Amortization Expense (+E, -SE) 40,000
Accumulated depreciation (+XA, -A) 40,000
