ADM1340 Ch9-Long Lived Assets

École de gestion TELFER

  • School of Management

  • Linked with Leadership

Chapter Overview: Long-lived Assets

  • Author: Shujun Ding, Ph.D.

Study Objectives

  • Determine the cost of property, plant, and equipment.

  • Explain and calculate depreciation.

  • Account for the disposal of property, plant, and equipment.

  • Illustrate how long-lived assets are reported in the financial statements.

  • Describe methods for evaluating the use of assets.

Property, Plant, and Equipment

  • Long-lived resources that:

    • Are controlled by the company.

    • Have physical substance.

    • Are used in the operation of a business.

    • Are not intended for sale to customers.

  • Provide benefits over many years.

Determining the Cost of Property, Plant, and Equipment

  • Recorded at cost, which includes:

    • Purchase price (including taxes and duties, less discounts/rebates)

    • Expenditures necessary to bring the asset to its intended location and readiness for use.

Types of Expenditures

  • Operating Expenditures:

    • Benefit only the current period.

    • Charged against revenue as an expense.

  • Capital Expenditures:

    • Capitalized as an asset.

    • Benefit future periods.

    • Increases investment in productive activity.

Land

  • Cost includes:

    • Purchase price

    • Closing costs (title, legal fees)

    • Additional costs for intended use preparation (less proceeds from salvage).

  • Depreciation: Land has an unlimited life and is not depreciated.

Land Improvements

  • Costs of structural additions (e.g., paving, fencing).

  • Decline in service potential over time, recorded separately from land, and depreciated over useful lives.

Buildings

  • Costs include:

    • Purchase price

    • Closing costs (legal fees, title, insurance)

    • Costs required to make the building ready for intended use.

  • For constructed buildings:

    • Contract price

    • Architect's fees

    • Building permits

    • Excavation cost

    • Interest costs during construction.

Equipment

  • Costs include:

    • Purchase price

    • Freight charges/insurance during transit

    • Assembly, installation, and testing.

Asset Retirement Costs

  • Cost for dismantling, removing, or restoring an asset when retired.

  • Estimated in advance and included in the cost of the asset.

Acquisition Cost of Property, Plant and Equipment (PP&E)

  • Acquisition cost includes:

    • Purchase price and necessary expenditures for intended use.

    • Includes transportation, installation, legal fees, insurance, testing fees, etc.

  • Excludes:

    • Unrelated expenditures, repair costs during installation, and financing charges.

Depreciation

  • Systematic allocation of cost over useful life.

  • A cost allocation process, not asset valuation, does not provide cash for replacements.

Factors in Calculating Depreciation

  • Cost: Purchase price plus costs to ready the asset for use.

  • Useful Life: Period the asset is expected to be available for use.

  • Residual Value: Estimated amount on disposal of the asset.

Depreciation Methods

  • Straight-Line: Used by majority of Canadian publicly-traded companies.

  • Diminishing-Balance: Decreases annual expense based on carrying amount.

  • Units-of-Production: Based on total units of production or activity expected.

Example - Straight-Line Method

  • A delivery van purchased on Jan. 1, 2012, costs $33,000 with estimated residual value of $3,000 and useful life of 5 years.

Example - Diminishing-Balance Method

  • A delivery van purchased and depreciation calculated based on the carrying amount at the beginning of the year.

Example - Units-of-Production Method

  • Life expressed in units of productions (e.g., kilometers for vehicles).

Other Depreciation Issues

  • Significant components may be depreciated separately.

  • Impairments: when carrying amount exceeds recoverable amount.

  • Cost vs. revaluation model under IFRS: fair market value.

Revising Periodic Depreciation

  • Revisions are needed if:

    • Capital expenditures during the useful life.

    • Impairment losses.

    • Change in estimated useful life/residual value or consumption pattern of economic benefits.

Disposals of Property, Plant, and Equipment

  • Update depreciation up to date of disposal.

  • Calculate carrying amount: Cost - Accumulated depreciation.

  • Calculate gain or loss: Proceeds - carrying amount.

Presentation of Long-Lived Assets

  • Reported as Property, Plant and Equipment and Intangible Assets in statement of financial position.

  • Disclosure of cost and accumulated depreciation of each major class of assets in financial statements or notes.

Key Ratios

  • Return on Assets = Profit ÷ Average Total Assets.

  • Asset Turnover = Net Sales ÷ Average Total Assets.

  • Profit Margin: Together with asset turnover explains return on assets ratio.