(1AA3) Chapter 6: PPE and Intangible Assets

Final Exam review

Acquisition Cost

• The cost at which an asset is reported on the balance sheet

• Used in calculating the depreciation expense

Cost principle

• When a business buys an asset, the cost they record isn’t just the purchase price.

• It includes everything necessary to prepare the asset for use.

Subsequent expenditures 

• Any expenditures once an asset is put to use

• Includes:

  • Revenue expenditures

  • Capital expenditures

Revenue Expenditures

• Expenditures that are necessary to keep the asset in good running condition 

• Classified as operating expenses on the income statement 

What is an immediate expense?

Maintenance or repair → expensed right away.

Capital expenditure

• Increase the useful life of an asset 

• Increase an asset's capacity 

• Improve the performance of an asset 0

• Added to the cost of the asset

Capitalizing a revenue expenditure will:

• Understate expenses

• Overstate net income

• Overstate assets 

Lump Sum purchases

Businesses buy more than one asset in a single transaction with a single quoted price 

• For example, a business acquires a building for $5 million 

• This $5 million covers the cost of the land and building of the asset 

• However, on the Balance Sheet, we can't have an account called Land and Building 

Depreciation

• The systematic allocation of an asset's cost over its useful life

• Not meant to reflect the drop in an asset’s value

Depreciation - cost

Acquistion cost of an asset

Salvage Value (or residual value)

What the company expects to recover from the sale of an asset at the end of its useful life 

Useful life

Number of years for which a business expects to use the asset 

Depreciation cost

Cost - Salvage Value

Accumulated Depreication (AD)

• The sum of depreciation 

•  Expense over the years since the asset was acquired  

• At the end of its useful life, AD = depreciable cost 

Book value

Cost - Accumulated Depreciation 

3 Depreciation methods

1. Straight line method (SLM)

2. Double diminishing balance / doubling declining balance (DDB)

3. Units of activity

Straight line method (SLM) 

• Depreciation expense is the same every year

Straight line method (SLM) - Formula

SLM annual depreciation expense = (cost – salvage value) / useful life 

Double declining balance (DDB) 

• Accelerated depreciation method 

• Yields the highest depreciation expense in the earliest years of an asset’s useful life 

• Lower depreciation expense in later years

Double declining balance (DDB) - Formula

DDB annual depreciation expense = beginning book value x depreciation rate 

• Depreciation rate = 2/ useful life 

Units of activity 

• Need to have a measure of activity, such as:  

  • Mileage for vehicles  

• Need to have an estimate of the total activity  

  • For example, need to know the total mileage for a vehicle over its useful life

Units of activity - Formula

Units of activity annual depreciation expense =

(cost – salvage value) x (units of activity / total units of activity) 

Sale of Long term assets

1. Record depreciation expense on the day of the assets sale

2. Record gains or losses on the sale of the asset

3. Record the journal entry

Sale of Long term assets - Journal Entry

Does depreciation reflect asset market value?

No, it allocates cost over useful life.

Can a fully depreciated asset still be used?

Yes, but no more depreciation recorded.

What do you record when disposing fully depreciated asset with no proceeds?

Remove asset and accumulated depreciation. No gain/loss.

When is an asset impaired?

When carrying amount > recoverable amount.

Recoverable amount

Higher of fair value (less cost to sell) or value in use.

What measures profitability?

Return on Assets (ROA)

• shows how efficiently a company uses its assets to generate profit.