Chapter 12 Capital Assets

Definition O Also know as fixed assets O Bought to be used in the business O They will be used over many accounting periods O Two types: O Tangible O Intangible O A Capital Asset is recorded at historical cost in accordance with the cost principle,

Tangible Assets O physical assets you can touch, which are usually property, plant and equipment, as well as natural resources.

Intangible Assets O rights and privileges that provide benefit but don't physically exist. O Examples include: O Patents O Copyrights O Leaseholds O Leasehold Improvements O Goodwill O Trademarks and Trade Names

Cost Principle O Include all costs to acquire asset and make it ready for use O Include purchase price, freight costs paid, testing and installation costs O These costs are capital expenditures O Benefit future periods O Costs that benefit only the current period are called operating expenditures O Capital Assets costs are capitalized instead of expensed

Capital Asset Acquisition Expenditures O Common examples of capital asset purchases and other costs that may be added to the asset: O Land = purchase price + real estate commission + legal fees + cost of draining, clearing and landscaping + street and sewage assessment + survey O Building = price + real estate commission + legal fees + repair and remodelling + payment to tenants for premature termination of lease O Equipment = invoice cost + transportation (or delivery cost) + insurance on delivery + assembly + installation (wages, expenses, etc.) + building changes (i.e. floor support) + wiring + inspection + test run costs

Amortization O The process of allocating cost to expense over the useful (service) life of an asset O Provides proper matching of expenses with revenues (GAAP) O A process of cost allocation, not determining market value O Does not accumulate cash for replacement of the asset

Calculating Amortization To calculate amortization, must determine: O The cost of the asset O Costs to acquire asset and make it ready for use O Its estimated useful (productive) life O Can be expressed in terms of time, units of activity or units of output O Based on assessment of use, obsolescence and other relevant factors O The estimated residual value O Estimated value of asset at end of its useful life

Amortization Methods O Three alternative methods: O Straight-line O Declining-balance O Units-of-activity (production) O Each method is acceptable under generally accepted accounting principles O Management selects the method that best measures an asset’s contribution to revenue O Once chosen, it should be applied consistently

Straight-Line Method O Most frequently used O Charges the same amount to expense each period of the asset’s useful life O Remember it is the cost minus salvage value divided by the useful life in years O Example $10,000-1,000/5 years = $1,800 per year O Amortization expense is the same each period

Units-of-Activity Method O Also called units-of-production O Useful life expressed as total units of production or activity O Charges a varying amount to expense for each period of useful life O Must estimate the total units of activity that will be obtained from asset

Units-of-Activity Method (cont’d) Total Estimated Units of Activity Amortizable Cost per Unit ÷ = Units of Activity during the Year Annual Amortization Expense x = Amortizable Cost Amortizable Cost per Unit 10,000-1,000/36,000 units = $0.25 per shoe 0.25x7000 = $1,750 amortization therefore the book value in the following year is $8,250 ( )

Declining-Balance Method O Amortization expense based on asset’s declining net book value O Cost less accumulated amortization O Amortization rate remains constant, but net book value declines each year (yields larger amortization expenses in the early years of asset’s life) Net Book Value at Beginning of Year Straight-Line Rate x 2 Annual Amortization Expense x =

Declining-Balance Method O Can also be called double declining balance as you can take the straight line rate and double it O Example: Step 1 Double-declining balance rate = 2/5 years = 40% Step 2 Amortization Expense = Double-declining balance rate x beginning period book value = 40% x 10,000 = $4,000 Net Book Value at Beginning of Year Straight-Line Rate x 2 Annual Amortization Expense x =

Comparing Methods O Regardless of the method used the total overall amortization expense is the same, the amount of expense varies throughout the years depending on the method chosen O Review Illustration 9-10 pg. 466 in the text

Disposals of Property, Plant and Equipment O Four steps required to record a disposal: 1. Update amortization O For the part of the year to the date of disposal 2. Calculate the net book value = Cost - Accumulated Amortization 3. Calculate the gain or loss = Proceeds – Net Book Value O Proceeds > net book value: gain O Proceeds < net book value: loss 4. Record the disposal

Journal for Discarding Capital Assets If fully amortized: Accumulated Amortization, Machinery 9000 Machinery 9000 To record the discarding of fully amortized machinery.

Journal for Discarding Capital Assets 1. If amortization is not up to date first journalize amortization: Amortization Expense500 Accumulated Amortization, Equipment500 To record six months amortization 2. Then the disposal: Accumulated Amortization, Equipment6500 Loss on disposal of equipment1500 Equipment 8000 To record discarding of machinery having a $1500 book value