Week 3 - PPE

Question 1

Component accounting

Answer 1

requires a company to identify and depreciate significant components with different useful lives separately

Question 2

Two important applications of the component method

Answer 2

• Asset retirement obligations

- Major inspections and overhaul

Question 3

Asset retirement obligations

Answer 3

• when at the end of the useful life something must be paid to get rid of the asset
• e.g. offshore drilling platform (oil companies get a concession to drill under the condition that they remove the platform and the end of life)
• decommissioning cost of the oil rig is treated as a separate component of the asset → allocated to the period of the oil rig in use
• projected cost of decommissioning is capitalized as a component of the asset at the start of the useful life // opposite entry is a provision, which is a liability

Question 4

Major inspections and overhaul

Answer 4

• e.g. Airplanes have a major overhaul every few years

- overhaul is capitalized as a component of an asset and depreciated over the period until the next overhaul

Question 5

Which depreciation method do most companies use?

Answer 5

Staight line depreciation

Question 6

Which depreciation method has an accelerated allocation?

Answer 6

Double declining balance (DDB)

Question 7

Which depreciation method never reaches zero?

Answer 7

DDB

Question 8

Which depreciation method is used for income tax purposes?

Answer 8

DDB. It provides the most depreciation and thus the largest tax deduction in the early life of the asset. The company can invest the tax savings to earn a return on the investment.

Question 9

Which depreciation method creates a smooth net income?

Answer 9

Units of production depreciation. Depreciation expenses rise and fall with the sales pattern.

Question 10

Limitations of the units of production depreciation

Answer 10

• does not take into account that a machine is underutilized

- results in a more bumpy pattern of depreciation charges

Question 11

Units-of-production depreciation per unit of output formula

Answer 11

cost-residual value/ useful life in units of production

Question 12

Straight line depreciation formula

Answer 12

(cost-residual value)/ useful life

Question 13

DDB formula

Answer 13

BV/(2/useful life)

Question 14

Criteria to be taken into account when determining an assets useful life

Answer 14

• expected usage of the asset
• expected physical wear and tear
• technical or commercial obsolescence
• legal or similar limits on the use of the asset

Question 15

Recoverable amount of an impaired asset

Answer 15

is the higher of the value in use and the fair value less cost to sell

Question 16

What is a cash-generating unit?

Answer 16

Smallest group of assets that generate flows that are largely independent of other assets

Question 17

Is depreciation connected to market value?

Answer 17

NO

Question 18

What happens when depreciation is recorded?

Answer 18

• the carrying amount of the asset is reduced (by accumulated depreciation) and the corresponding expense results in a reduction in equity.

Question 19

What fixed asset is never depreciated?

Answer 19

Land

Question 20

List some intangible assets

Answer 20

goodwill, software, patents, development costs, brands

Question 21

Relative-sales-value method

Answer 21

• business purchases several assets as a group or basket

- TC are divided among the assets according to their relative sales values

Question 22

capital expenditures

Answer 22

expenditures that increase the asset’s capacity or extend its useful life; these costs are capitalized so added to the asset account and not expensed immediately

Question 23

Formula for carrying amount of PPE

Answer 23

Cost of asset - accumulated depreciation

Question 24

asset turnover formula

Answer 24

sales/ average assets

• how many sales a business can generate from its assets

Question 25

return on assets

Answer 25

net profit/ average assets

Question 26

PPE is recognized in financial statements when

Answer 26

1. It is probable that future economic benefits associated with the time will flow to the entity
2. The cost of the item can be measured reliably

Question 27

Basic rule for determining the cost of an asset

Answer 27

• the cost of any asset is the sum of all the costs incurred to bring the asset to its intended use