Review of Chapter 6

Cost of inventory Account for inventory perpetual, periodic Costing inventory methods: Specific ID, Weighted Average, FIFO Accounting principles: comparability, disclosure Lower of Cost-and-Net-Realizable Value Rule Effect of inventory errors Ratios: Gross profit percentage and inventory turnover

Review Question #1
Using the information on the overhead projector, the cost of inventory at July 31, 2006 using the FIFO method is: a. b. c. d. 9,500 $10,800 $11,000 $13,400

Property, Plant, and Equipment, and Intangible Assets Chapter 7

Learning Objective 1 Determine the cost of property, plant and equipment.

Types of Assets
Long-lived assets used in the operation of a business are divided into categories: Property, Plant & Equipment
(Tangible long-lived assets)

Intangible Assets

Property, Plant and Equipment

Property, Plant and Equipment such as land, buildings, machinery and equipment, etc. are held for use in the business The cost of these assets is the purchase price plus any other amount paid to acquire it and make it ready for use. Examples of costs are: purchase price less any discount, freight, taxes, commissions, assembly costs, installation costs, testing costs, etc.

Example: Determining the Cost of Land

A business signs a $300,000 note payable to purchase land for a new store site. It pays $10,000 in real estate commission, $8,000 in back property tax, $5,000 for removal of an old building, a $1,000 survey fee, and $260,000 to pave the parking lot. What is the cost of the land?

Determining the Cost of Land

Purchase price of land Add related costs: Real estate commission $10,000 Back property tax 8,000 Removal of buildings 5,000 Survey fees 1,000 Total cost of land $300,000

24,000 $324,000

Lump-Sum (or Basket) Purchases of Assets

When a company purchases a group of assets, they must identify the cost of each asset using the relative sales value. Example: Company paid $1 million for building and land Market value of building = $960,000 land = 240,000 Total market value $1,200,000

Lump-Sum (or Basket) Purchases of Assets

Allocation: Building = Land = Total cost allocated Dr Building Dr Land Cr Cash

$1,000,000

1,000,000

Capital Expenditure versus an Immediate Expense

Does the expenditure increase capacity or efficiency or extend useful life?

Capital Expenditures: Record an asset

Expenses: Record an expense

Capital Expenditure versus an Immediate Expense

Record an Asset for Capital Expenditures Extraordinary repairs: Major engine overhaul Modification of body for new use of truck Addition to storage capacity of truck Record Repair and Maintenance Expense Ordinary repairs: Repair of transmission or other mechanism Oil change, lubrication, etc. Replacement tires, windshield Paint job

Question #2
Land and building were bought for a total of $485,000. The market value for the land was $175,000 and $325,000 for the building. What amounts should be recorded for them? Land Building a. $175,000 $325,000 b. $160,000 $325,000 c. $175,000 $310,000 d. $169,750 $315,250

Learning Objective 2

Account for Depreciation.

Depreciation
Depreciation allocates the cost of the property, plant and equipment to expense over future periods The cost of using it is recorded in the same period the revenue is earned An adjusting entry is prepared using an estimate

Depreciation - Terminology
Cost all costs incurred to get the asset ready for use Accumulated depreciation depreciation expensed over the accounting periods Estimated useful life the length of service the business expects from the asset Estimated residual value it is the expected cash value of an asset at the end of its useful life

Depreciation Methods
Straight-line (SL) Units-of-production (UOP) Diminishing balance or Double-diminishing-balance (DDB)

Depreciation Methods - Example

Cost of delivery van $55,000 Estimated residual value 5,000 Estimated useful life 4 years Units of production 200,000 km Actual kms driven: Yr. 1= 52,000 Yr. 3 = 47,000 Yr. 2 = 48,000 Yr. 4 = 53,000

Straight-Line Method
(Cost Residual value) Years of useful life ($55,000 $5,000) 4 = $12,500 Year 1 depreciation: Year 2 depreciation: Year 3 depreciation: Year 4 depreciation: Total depreciation: $12,500 12,500 12,500 12,500 $50,000

Units-of-Production Method

Year 1: 52,000 km $0.25 = $13,000 Year 2: 48,000 km $0.25 = 12,000 Year 3: 47,000 km $0.25 = 11,750 Year 4: 53,000 km $0.25 = 13,250

Double-Diminishing-Balance Method
Straight-line rate per year: 100% 4 = 25% Double-diminishing balance: 2 times the straight-line rate = 50%
Year 1: 55,000 0.50 = $27,500 Year 2: 55,000-27,500 x .50 = $13,750 Year 3: 55,000-27,500-13,750 x .50 = $6,875 Year 4: $1,875** Total accumulated depreciation =$50,000 **The asset is not depreciated below residual value

Comparing Depreciation Methods

Amount of Depreciation per Year

Year SL UOP DDB 1 $ 12,500 $13,000 $27,500 2 12,500 12,000 13,750 3 12,500 11,750 6,875 4 12,500 13,250 1,875 Total $50,000 $50,000 $50,000

Question #3
On Jan. 1, three years ago, the company bought a machine for $15,000. The estimated useful life was 10 years and the residual value was $3,000. If double declining balance is used, what is the depreciation expense for the third year? a. $1,500 b. $1,536 c. $1,920 d. $3,000

Learning Objective 3 Examine additional depreciation topics

Depreciation for Partial Years

If a company buys an asset other than at year-end: 1) Compute the depreciation for the year 2) Multiply by the fraction of the year you held the asset

Depreciation for Partial Years

Suppose a calendar-year business purchases a building on April 1 for $500,000 with an estimated life of 20 years and an estimated residual value of $80,000. What is the current years depreciation using the straight-line method?

Depreciation for Partial Years

Full-year depreciation: ($500,000 $80,000) 20 = $21,000 Partial-year depreciation: $21,000 9/12 = $15,750

Changing the Useful Life of a Depreciable Asset

Assume an asset cost of $40,000, an eight-year useful life with no residual value, and the straight-line method. $40,000 8 = $5,000 depreciation per year What is the carrying amount after two years? $40,000 $10,000 = $30,000

Changing the Useful Life of a Depreciable Asset

Management believes the asset will remain useful for an additional ten years. $30,000 10 = $3,000 (new depreciation per year)

Fully Depreciated Assets

An asset can be used after it is fully depreciated. The asset and its depreciation account remain in the ledger with no additional depreciation entries.

Learning Objective 4 Analyze the effect of property, plant and equipment derecogniton.

Derecognition of Property,Plant and Equipment

Derecognition is used to refer to property, plant and equipment that is either no longer useful or it is sold If assets are junked before being full depreciated, the company incurs a loss on the disposal Before accounting for the derecognition, bring the depreciation up to date

Derecognition of Property,Plant and Equipment

Example: A company disposes of equipment that cost $8,000. Accumulated depreciation is $6,000 and the carrying amount is $1,000. The journal entry is: Accumulated depreciation 6,000 Loss on disposal 2,000 Equipment

8,000

Accounting for the Sale of Property, Plant and Equipment

1. Bring the depreciation up to date. 2. Determine the carrying amount and compare with the selling price. 3. Determine if there is a gain or loss 4. Record the disposal

Selling a Property, Plant & Equipment: Example

Equipment which cost $10,000 on 1/1/2003 is sold on Sept. 30, 2006 for $5,000. It has been depreciated on a straight-line basis over its 10 years estimated useful life. There is no residual value.

Selling a Property, Plant & Equipment: Example

Bring the depreciation up to date: Dr Depreciation expense 750 Cr Accumulated depreciation ($1,000 9/12 = $750)

750

Selling a Property, Plant & Equipment: Example

What is the accumulated depreciation on September 30, 2006? $10,000 10 = $1,000/year $1,000 3 years = $3,000 $1,000 9/12 = $750 $3,000 + $750 = $3,750

Selling a Property, Plant & Equipment: Example

Record the sale. What is the gain or loss? September 30, 2006 Cash 5,000 Accumulated Amortization 3,750 Loss on Sale of Equipment 1,250 Equipment To record sale of equipment for $5,000

10,000

Other Issues in Accounting for Property, Plant & Equipment

Depreciation for Tax Purposes Depreciating Significant Components Impairment Revaluation Model

Depreciation for Tax Purposes

Many businesses use the straight-line method The Income Tax Act permits taxpayers to use an accelerated depreciation for tax purposes A business can use one method for accounting purposes and another method for tax purposes

Depreciating Significant Components

IFRS require that significant components of an item of property, plant and equipment be depreciated separtely

Impairment
At each reporting date, a company should review its property, plant and equipment to see if an asset is impaired Impairment occurs when then the carrying amount exceeds its recoverable amount ie obsolescence, physical damage and loss in market value

Impairment
Loss on impairment xxx Accumulated depreciation xxx

If the situation changes, IFRS does permit a company to reverse the impairment loss by writing the asset up to its carrying amount

Revaluation Model
Under the revaluation model, the asset is recorded at cost when purchased but then measured at its fair value less any accumulated depreciation less any accumulated losses Fair value is the price at which the asset could be sold

Learning Objective 5 Account for intangible assets and amortization.

Intangible Assets

Patents Copyrights Trademarks

Franchises Licences Goodwill

Intangible Assets
Intangible assets are recorded at acquisition cost and are often the most valuable assets. The residual value is often zero. Intangible assets fall into 2 categories: 1. Intangibles with finite lives amortized 2. Intangibles with indefinite lives not amortized but checked for impairment

Example: Intangible Assets: Patents

Patents are federal government grants. They give the holder the right to produce and sell an invention. Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

Example: Intangible Assets: Patents

January 1 Patents Cash To acquire a patent

170,000 170,000

December 31 Amortization Expense 34,000 Accumulated amortization To amortize the cost of a patent

34,000

Intangible Assets
Copyrights films, novels, software, etc - extend 50 years beyond the creators life Tradenames are assets that represent distinctive identifications of a product or service Franchises/Licences granted by private business or government to sell a product or service

Question #4
A company paid $80,000 to acquire a patent, with an expected useful life of 4 years, on June 30, 2007.The entry to record amortization expense at Dec. 31/07 is: a. Dr Amortization expense 20,000 Cr Accumulated amortization b. Dr Amortization expense 10,000 Cr Accumulated amortization c. Amortization expense 10,000 Cr Patent d. Dr Amortization expense 20,000 Cr Patent

20,000 10,000 10,000 20,000

Learning Objective 7 Reporting long-lived assets on the statement of cash flows

Reporting Capital Asset Transactions: The Cash Flow Statement

The capital asset transactions that appear on the cash flow statement are: Acquisitions and sales of capital assets (investing activities) Depreciation/Amortization expense (added to operating activities)

End of Chapter 7