ACCT 2110 - Chapter 7: Operating Assets

What are operating assets?

Long-lived assets used in the normal course of business operations.

What are the three categories of operating assets?

Property, plant, and equipment (PP&E); intangible assets; natural resources.

What is property, plant, and equipment (PP&E)?

Tangible long-lived assets used in operations, also called fixed or plant assets.

What does tangible mean?

An asset has physical substance and can be seen or touched.

Name four examples of PP&E.

Land, land improvements, buildings, and equipment.

What are land improvements?

Structural additions to land, such as parking lots, fences, lighting, and driveways.

What is classified as a building asset?

A structure used in operations, such as an office, factory, or warehouse.

What is classified as equipment?

Operating assets such as machinery, vehicles, or furniture.

What are intangible assets?

Long-lived assets lacking physical substance, often based on legal or contractual rights.

Name four intangible assets.

Patents, copyrights, trademarks, and goodwill.

What are natural resources?

Naturally occurring economic materials, such as oil, timber, coal, and mineral deposits.

What principle determines the initial recorded cost of a fixed asset?

Historical cost principle.

What costs are included in the acquisition cost of a fixed asset?

Purchase price plus costs necessary to acquire and prepare the asset for use.

What typical costs are included in the cost of land?

Purchase price, commissions, closing costs, delinquent property taxes, grading, and demolition net of salvage.

Are clearing and grading land capitalized to Land?

Yes, as costs necessary to prepare the land for use.

What is included in the cost of land improvements?

Purchase price, sales taxes, and installation costs.

What is included in the cost of a building?

Purchase price or construction costs, permits, architect fees, closing costs, excavation, and remodeling.

What is included in equipment acquisition cost?

Purchase price, sales taxes, freight, transit insurance, installation, and trial runs.

Are costs of removing an old machine included in the cost of a new machine?

No. Removal of the old machine is not a cost of acquiring the new one.

Are costs of testing a new machine included in its acquisition cost?

Yes. Trial runs prepare the machine for use.

Are sales taxes on new equipment capitalized?

Yes, sales taxes are part of the equipment acquisition cost.

What is depreciation?

Systematic allocation of a tangible operating asset's cost to expense over periods of use.

Which PP&E asset is generally not depreciated?

Land.

What is depreciation expense?

The current period's allocation of an asset's cost, reported on the income statement.

What is accumulated depreciation?

Total depreciation recorded since acquisition; a contra-asset on the balance sheet.

What is a contra-asset?

An account that reduces the reported amount of its related asset.

What is book value (carrying value) of equipment?

Original cost minus accumulated depreciation.

What three inputs are required to calculate depreciation?

Asset cost, expected useful life, and residual (salvage) value.

What is useful life?

The time during which a company expects to benefit from using the asset.

What is residual (salvage) value?

The estimated amount the asset will be worth at the end of its useful life.

What is depreciable cost?

Asset cost minus residual value.

What is the maximum total accumulated depreciation over an asset's life?

Its depreciable cost: cost minus residual value.

Which three depreciation methods does Chapter 7 cover?

Straight-line, declining balance, and units-of-production.

What is straight-line depreciation?

An equal amount of depreciation expense each year of useful life.

What is the straight-line depreciation formula?

(Cost - residual value) / expected useful life.

What is the most widely used depreciation method in the slides?

Straight-line.

A machine costs $50,000, has $5,000 salvage, and lasts 5 years. Straight-line per year?

($50,000 - $5,000) / 5 = $9,000.

What is the annual straight-line depreciation rate for a 5-year life?

1 / 5 = 20%.

What is declining-balance depreciation?

An accelerated method multiplying beginning book value by a constant rate.

How does declining-balance depreciation expense change over time?

Usually highest in early years and lower in later years.

Why is declining-balance called accelerated depreciation?

It allocates more depreciation expense to early years than straight-line does.

What kinds of assets suit declining-balance depreciation?

Assets subject to rapid obsolescence or rapidly declining service potential.

What is the declining-balance rate formula?

Multiplier (m) times straight-line rate.

What is double-declining-balance (DDB) rate?

2 times the straight-line rate, or 2 / useful life.

What is declining-balance depreciation expense formula?

Declining-balance rate times beginning-of-period book value.

What book value is used in declining-balance depreciation?

Beginning-of-period cost minus accumulated depreciation.

A $30,000 asset has a 5-year life. What is its double-declining rate?

2 / 5 = 40%.

A $30,000 asset uses 40% declining balance. First-year depreciation?

$30,000 x 40% = $12,000.

After $12,000 depreciation on a $30,000 asset, what is its book value?

$30,000 - $12,000 = $18,000.

What limits declining-balance depreciation in an asset's final years?

Depreciation must not reduce book value below residual value.

What is units-of-production depreciation?

An allocation method based on actual usage of an asset.

What is the units-of-production depreciation rate formula?

(Cost - residual value) / total expected units of usage.

What is units-of-production depreciation expense formula?

Depreciation cost per unit x actual units used.

Machine costs $42,000, salvage $2,000, expected 100,000 units. Rate per unit?

($42,000 - $2,000) / 100,000 = $0.40 per unit.

Using $0.40 depreciation per unit, what is expense for 15,000 units?

15,000 x $0.40 = $6,000.

Which depreciation method best tracks mileage driven by delivery vehicles?

Units-of-production, using miles driven as actual usage.

Which depreciation method produces equal yearly expense?

Straight-line.

Which depreciation method depends most directly on actual usage?

Units-of-production.

Which depreciation method typically produces declining yearly expense?

Declining-balance.

Can tax depreciation differ from financial-statement depreciation?

Yes. Financial-reporting and tax methods need not be the same.

What is MACRS?

Modified Accelerated Cost Recovery System, commonly used for tax depreciation.

Is MACRS acceptable for financial reporting according to these slides?

No; the slides say MACRS is for tax reporting, not financial reporting.

What is a revenue expenditure?

A cost that maintains existing asset benefits; expensed when incurred.

What is a capital expenditure?

A cost to acquire or improve a long-term asset or extend its life, efficiency, or capacity.

How are routine repairs and maintenance recorded?

As expenses in the current period.

How are major repairs that extend an asset's useful life recorded?

Capitalized and depreciated over the asset's remaining useful life.

How is an addition to a building recorded?

Capitalized and depreciated over the shorter remaining life of the asset or addition.

How is a betterment that increases efficiency recorded?

Capitalized and depreciated over the improved asset's remaining useful life.

Is an ordinary oil change a capital or revenue expenditure?

Revenue expenditure; expense it now.

Is replacing equipment controls to increase efficiency capital or revenue?

Capital expenditure; capitalize the improvement.

What changes can require revising depreciation?

Changes in useful life, residual value, or capital expenditures.

What is the first step in revising depreciation?

Calculate the asset's book value as of the revision date.

How is revised straight-line depreciation calculated?

(New book value - revised residual value) / remaining useful life.

Do you recalculate prior years' depreciation for a new estimate?

No. Recalculate depreciation for current and future periods.

Book value is $24,000, new residual $4,000, remaining life 5 years. Annual depreciation?

($24,000 - $4,000) / 5 = $4,000.

What is voluntary disposal of a fixed asset?

A company intentionally disposes of an asset it no longer needs.

What is involuntary disposal of a fixed asset?

An asset is lost or destroyed by theft, nature, or accident.

What is the first step before recording disposal of a fixed asset?

Record depreciation through the date of disposal.

Which accounts must be removed when equipment is disposed of?

Remove the asset's original cost and its related accumulated depreciation.

What is the formula for gain or loss on disposal?

Proceeds from sale minus book value of the asset.

When is a gain recorded on disposal?

When sales proceeds exceed the asset's book value.

When is a loss recorded on disposal?

When sales proceeds are less than the asset's book value.

Asset book value $8,000, sold for $11,000. Gain or loss?

$3,000 gain.

Asset book value $8,000, sold for $5,000. Gain or loss?

$3,000 loss.

Equipment cost $20,000, accumulated depreciation $15,000. Book value?

$5,000.

What is the journal entry to record depreciation expense?

Debit Depreciation Expense; credit Accumulated Depreciation.

What is the basic disposal journal entry when equipment is sold at a gain?

Debit Cash and Accumulated Depreciation; credit Equipment and Gain on Disposal.

What is the basic disposal journal entry when equipment is sold at a loss?

Debit Cash, Accumulated Depreciation, and Loss on Disposal; credit Equipment.

What is impairment of a fixed asset?

A permanent decline in the asset's expected future benefits or service potential.

What are possible indications of impairment?

Obsolescence, operating losses, new technology, regulation, or increased competition.

Does depreciation attempt to measure fair value?

No; depreciation is cost allocation, so book value may differ from fair value.

What is Step 1 of the slide's impairment process?

Check whether there is an indication of impairment.

What is Step 2 of the slide's impairment process?

Compare estimated future cash flows with net book value; if they exceed it, stop.

What is Step 3 of the slide's impairment process?

If fair value is below book value, reduce book value to fair value and record the difference.

Asset book value $50,000, cash flows $40,000, fair value $35,000. Impairment loss?

$15,000, using the slide's recoverability test and fair-value measurement.

Asset book value $50,000, future cash flows $60,000. Impairment under the slides' test?

No. Estimated future cash flows exceed book value.

How are acquired intangible assets initially measured?

At cost, including purchase price and necessary registration, filing, and legal fees.

How are internally developed research and development costs recorded?

Generally expensed as R&D when incurred, as described in the slides.

What is a patent?

A legal right to make, sell, or use an invention or process.

What is a copyright?

A right to publish, sell, or control a literary or artistic work.