Accounting - depreciation section

What does it mean when cost are capitalized

cost are recongized and put on the balance sheet as an asset

What is difference between depreciation and amortization

Depreciation: used for tangible assets

diminishes value over time

indirectly reduces

Amortization: used for intangible assets

gradually write off cost over a period

directly reduces

What are improvements, what should happen, and what are the methods

involves the replacement of a major component of an asset

• should be capitalized by increasing the book value of the related asset and depreciate over the useful life of the new asset

  Methods

  1. Substitution

  2. Capitlization of new cost

  3. Reduction of Accumulated Depreciation

How are additions handled?

How about replacements?

adding a new major component to an existing asset should be capitalized because future benefits are increased

capitlized by increasing the book value of the related asset and depreciating it over the useful life of the new asset

How are repairs and maintenance handled?

• made to maintain a given level of benefits from an asset

• does not increase future benefits

• future benefits do not exceed expectation

• expenditures for these should be expensesed

What are material threasholds for capitlization

many companies set threasholds

subsequent expenditures

• additions

• repaid and maintenance

• improvement

• replacement

• rearrangements

How can expenditures increase future benefits?

1. An extension of the useful life of an asset

2. An increase in the operating efficiency of a asset

   1. increase in the quantity produced or services produced

   2. decrease in future operating cost

3. Increase in the quality of goods or services produced by an asset

How do you handle expenditures after aquisition?

How do you handle both methods?

• expenditures that produce benefits→ CAP

• expenditures that maintain a given level of expenditures → Expensed

1. Capitlization: increasing the assets book value & creating a new asset

2. Expensing: maintaing a given level of benefits

What does it mean if an asset is impaired?

What is the impairment loss process?

the carryings value is less than what the company is going to sell it for (book value then the profits the business will recieve from asset)

Impairment Loss Process

1. Is the asset impaired?

   an impairment occurs when an undiscounted sum of estimated future cash flows < book value

2. If Impaired

   record impairment loss for FV - BV

3. If Not impaired

   no loss recorded

Impairment value becomes the new cost base for future allocation

How do you handle indefinite life Intangible Assets other than Goodwill

• tested for impairment more frequently if events could affect

• can have qualitative test before quantitative test

• measurement of impairment loss is a one step process

• fair value < book value → impairment loss

• no recoverability test

How do you test for recoverability?

What is the measurement of impairment loss?

compare the book value to the undiscounted future cash flows

book value > est undiscounted future cash flow → loss

Impairment Loss= Fair Value - book value

What is the difference between undiscounted and discounted cash flows?

What needs to be included?

Undiscounted: used to determine if an impairment loss has occured

Discounted: cash flows are used to estimate fair value to determine the amount of loss

Includes

• Disclosure Note

  • facts and circumstances leading to impairment

  • method used to determine fair value

What is the Fair Value?

• the amount the asset could be willing to buy between two parties

• fair value is estimated as the discount present value of future cash flows

What are the different guidelines when applying impairment of value to assets held and used?

Plant, Property, Equitpment, and intangible assets Finite Useful LIfe

• subject to depreciation, depletion, or amortization

Intangible assets with Indefinite Useful Lives

• not subject to amortization

What are potential events or changes in circumstances?

• signficiant decrease in market price

• adverse change in how assets are being used

• change in legal factors

• actual cost accumulated higher than expected

• projection of continuing losses on an asset

• that an asset will be disposed off before the end of its estimated useful life

When do you test for impairment?

only if events or changes in circumstances indicate that the book value of asset may not be recoverable

What is the normal assumption when allocating the cost of an asset over its useful life?

there has been no significant reduction in the anticipated total benefits or service potential of the asset

However what is important to do if there has been an impairment first step?

write down if there has been a signficant impairment of value

• a write down can provide important information about the future cash flows that a company can generate from using the asset

What is cost allocation used for?

property, plant, equipment, and intangible assets are purchased with the expectation that will provide future benefits for certain years

• part of revenue generating operations

• cost allocated to periods of use

What are the three forms of cost allocation?

1. Depreciation

   for plant and equipment

2. Depletion

   for natural resources

3. Amortization

   for intangible assets

How do you go about measuring cost allocation?

requires that three factors established at the time the asset is put to use

• Service life: the estimated use that the company expects to receive from the asset

• Allocation Base: the cost of the asset expected to be consumed during its service life

• Allocation Method: the pattern in which the allocation base is expected to be consumed

What is the service life?

amount of use that the company expects to obtain from an asset before its disposal

• expressed in units of time or units of activity

Service Life < Physical Life

What is the allocation base?

amount of cost to be allocated over an assets service life

Allocation Base = Initial value of asset at Acquisition - Residual (salvage) value

• residual value: amount expected to be received for the asset at the end of service life - any disposal cost

What is the allocation method?

a method should be selected that corresponds to the pattern of benefits received from the assets use

• Systematic and Rational manner

  1. Time Based: allocates the depreciable base according to the passage of time

  2. Activity Based: allocates the depreciable base using a measure of the assets input or output

What are the depreciation methods under time based?

1. Straight Line

   allocates an equal amount of depreciable base to each year of the assets life

2. Accelerated Methods

   Declining pattern of depreciation, with higher depreciation in the earlier years of the assets life and lower depreciation in later years

   1. Declining Balance Method: multiplies beg of year book value by annual rate that is multiple of SL method

   2. Sum of Years Digits: multiplies depreciable base by declining fraction

What are the depreciation methods under activity based?

Units of Production: computes a deprecation rate per measure of activity and then multiplies this rate by actual activity to determine periodic depreciation

What are benefits of the methods?

Straight Line: results in less depreciation in ealier years of an assets life compared to accelerated. Postive impact on NI earlier years, negative on later

Accelerated Methods: results in more depreciation in earlier year. Greater tax deductions. No constraints on using different methods.

Activity Based depreciation typically provides a better match of revenues and expenses

What goes with dispostion of depreciation?

Disposition: selling or transfering ownership

• gain or loss recognized for the difference between the consideration received and the assets book value

  Equation?

What are retirements for depreciation?

instead of selling a used asset, a company may retire (abandon) the asset

At Time of Retirement

• asset account and the corresponding accumulated depreciation account are removed from the book

• a loss equal to the remaining book value of the asset is recorded.

What does it mean that intangible assets are subject to amortization?

Useful Life

• legal, regulatory, contraction provisions often limit useful life of an intangible asset

• useful life can be less then legal life

Residual Value

• expected residual value of an intangible asset is usually zero

• if not zero, will probably benefit another entity

Allocation Method

• method of amortizations should reflect the pattern of use of the asset in generating benefits

What intangible assets are not subject to amortization?

intangible assets that are determined to have an indefinite useful life is not subject to periodic amortization

• indefinite if there is no foreseeable limit on period of time cash flows expected

• indefinite are still subject to impairment

Examples indefinite life intangible assets

Goodwill, trademark, tradenames

What is a change in estiamte?

accounted for prospectively

reflected in the financial statements of the current and future periods

• disclosure note effect change in current period

  • net income

  • related per share amounts

requires a clear justification why new method is perferable

How do you calculate straight line?

Machine cost - residual value / years

How do you calculate accelerated depreciation or double declining method?

Machine cost x (1/ years x 2)

• no use of residual

How do you calculate sum of years digits?

Machine cost - residual value * ( n / n(n+1)/2 )

How do you calculate units of production?

Machine cost - salvage value / est production = rate * production

Impairment Loss Test?

and Measurement Test?

and journal entry?

Impairment Loss Test = Undiscoutned future cash flows > BV

Measurement Test= FV - BV

Loss on impairment

• accumulated depreciation

What could expenditures subsequent to aquisition look like?

Building cost 230,000

accumulated depreciation 160,000

sold parts 12,000

Old building cost 200,000

capital expenditures = 230,000 - 12,000

how could subsequent expenditures be dealt with and what are they

Repairs and Maintenance

• expenditures to maintain a given level of benefit

• expenses in the period incurred

Additions

• addition of a new major component to an existing asset

• capitalize and depreciate over short of remaining useful life

Improvements

• the replacement of a major component

• capitalize and depreciate over the useful life of improved

Rearrangements

• expenditures to reconstruct and asset without repairs and maintenance, additions, improvements, rearrangements

• if benefits are material then capitalize and depreciate