Chapter 8: Accounting for Long-Term Assets
Accounting for Long-Term Assets - Study Notes
Chapter Overview
Chapter 8 Learning Objectives:
Conceptual:
C1: Compute the cost of plant assets.
C2: Explain depreciation for partial years and changes in estimates.
C3: Distinguish between revenue and capital expenditures, and account for them.
Analytical:
A1: Compute total asset turnover and apply it to analyze a company’s use of assets.
Procedural:
P1: Compute and record depreciation using the straight-line, units-of-production, and declining-balance methods.
P2: Account for asset disposal through discarding or selling an asset.
P3: Account for natural resource assets and their depletion.
P4: Account for intangible assets.
P5: Appendix 8A—Account for asset exchanges.
Plant Assets
Definition of Plant Assets:
Plant assets are often referred to as Property, Plant assets, and Equipment.
Characteristics:
Expected to benefit future periods.
Actively used in operations.
Tangible in nature.
Four Key Issues in Managing Plant Assets:
Acquisition:
Compute cost.
Use:
Allocate cost to periods benefited.
Expenditures:
Account for subsequent expenditures.
Disposal:
Record disposal.
Learning Objective C1: Cost of Plant Assets
Acquisition Cost:
All expenditures needed to prepare the asset for its intended use.
Includes:
Purchase price
Installation costs (assembling, testing)
Insurance while in transit
Taxes and transportation charges
Machinery and Equipment costs include brokerage fees, title fees, and attorney fees.
Buildings: reported at cost, including purchase price and transaction expenses.
Land Improvements: such as parking lots and fences, depreciated over their useful life.
Land itself is not depreciable and includes costs like real estate commissions and surveying fees.
Example of Lump-Sum Purchase:
A company like CarMax pays $90,000 for land appraised at $40,000 and a building appraised at $60,000.
The cost allocation is based on their relative market values.
Learning Objective P1: Depreciation Methods
Definition of Depreciation:
It is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use.
Cash flow remains unaffected by depreciation; it is purely for accounting purposes.
Factors Required for Computing Depreciation:
Cost of the asset.
Salvage Value: Estimated residual value at the end of its useful life.
Useful Life: Estimated duration the asset will be used.
Depreciation Methods:
Straight-Line Method:
Depreciation Expense = (Cost - Salvage Value) / Useful Life.
Units-of-Production Method: Two-step process:
Step 1: Depreciation Per Unit = (Cost - Salvage Value) / Total Units of Production.
Step 2: Depreciation Expense = Depreciation Per Unit × Number of Units Produced in the Period.
Declining-Balance Method:
Accelerated method where a fixed rate is applied to the declining book value of the asset.
Comparative Analysis:
Companies may choose different methods of depreciation based on tax regulations and financial reporting needs.
Depreciation for Tax Reporting:
Corporations often use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes; this does not factor in the asset's useful life or salvage value.
Learning Objective C2: Partial-Year Depreciation and Estimate Changes
Partial-Year Depreciation:
When a plant asset is purchased during the year, calculate depreciation for the fraction of the year the asset is owned.
Example: If a machinery with a cost of $10,000, a salvage value of $1,000, and a useful life of 5 years is purchased on October 1, 2020, its depreciation expense would be calculated for the remaining months of that year.
Changes in Estimates:
Depreciation requires estimates of useful life and salvage value. Changes can occur due to new information.
Example: A machinery initially bought for $10,000 may need a revised estimate of remaining useful life or salvage value after its initial assessment.
Learning Objective C3: Revenue vs. Capital Expenditures
Revenue Expenditures:
Do not materially increase the plant asset’s life or capabilities.
Recorded as an expense in the current period and reported on the income statement.
Capital Expenditures:
Provide benefits extending beyond the current period.
Recorded as additions to the asset account, reported on the balance sheet.
Characteristics:
Revenue: Ordinary repairs (maintain normal operating condition, do not increase productivity or life).
Capital: Major overhauls (extend life or productivity).
Learning Objective P2: Asset Disposal
Process for Disposal of Assets:
Update depreciation to the date of disposal.
Remove accumulated depreciation and record the asset cost.
Recognize any gain or loss from the disposal.
Examples of Different Disposal Methods:
If cash received is greater than book value, record as a gain.
If cash received is less than book value, record as a loss.
If cash received equals book value, no gain or loss.
Learning Objective P3: Natural Resource Asset Accounting
Natural Resource Depletion:
Total cost is charged to depletion expense over periods benefited, based on extraction from the environment.
Examples: Oil, coal, gold.
Cost Determination Example:
A mineral deposit with a purchase cost of $500,000 and zero salvage value, with a depletion charge of $2 per ton. If 85,000 tons are mined, the depletion charge equals $170,000.
Learning Objective P4: Intangible Assets
Definition:
Non-physical assets used in operations that may have limited or indefinite lives. Recorded at purchase cost.
Cost Determination and Amortization:
Various types of intangible assets include patents, copyrights, franchises, goodwill, etc.
Patents and Copyrights:
A patent grants the owner exclusive manufacturing rights for 20 years.
Copyright offers exclusive rights to publish or sell creative works for the creator's life plus 70 years.
Research and Development:
Costs are expensed as incurred and are not recorded as intangible assets under GAAP.
Learning Objective A1: Total Asset Turnover
Definition:
Total asset turnover measures a company's efficiency in using its assets.
Formula:
Provides insights into sales generation relative to asset investment.
Learning Objective P5: Asset Exchanges
Exchanges of Plant Assets:
Plant assets may be exchanged for newer equipment, with trade-in allowances affecting the accounting treatment.
Commercial Substance: A transaction that alters future cash flows is treated differently for recording.
Example:
A new equipment acquisition might include cash payments and trade-ins that modify the way gains and losses are recorded depending on their book value at the time of exchange.
End of Chapter 8
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