1 Learning Objectives After studying the material in this chapter you will be able to do the following: LO1Define capital assets and recognize their different categories. LO2Explain the strengths and limitations of the different methods for valuing capital assets on the balance sheet. LO3Recognize how to account for the purchase of capital assets. LO4Describe the different method of depreciating capital assets and understand the implications of the different methods for financial statements and for users of the financial statements. LO5Recognize the information about capital assets that is disclosed in financial statements. Copyright © 2013 McGraw-Hill Ryerson Limited

2 Cost Allocation Copyright © 2013 McGraw-Hill Ryerson Limited LO4

3 Depreciation Reflects the usage being made of asset ▫Utilization of economic value of asset ▫Match costs to revenues Reflects the obsolescence of the asset Depreciate only cost less residual value Not all assets are depreciated Copyright © 2013 McGraw-Hill Ryerson Limited LO4

4 Depreciation and Market Value Depreciation allocates costs of capital assets to expense in systematic ways Carrying amount of asset is not an estimate of market value Copyright © 2013 McGraw-Hill Ryerson Limited LO4

5 Depreciation Methods Straight line Accelerated Usage-based Methods allocate costs of capital assets to expense in different ways Results in different net income and carrying amounts in each year of assets’ life Copyright © 2013 McGraw-Hill Ryerson Limited LO4

6 Straight Line Depreciation Amortize in equal increments Amortize over useful life to residual value Implies equal contribution of asset to earning power each year Copyright © 2013 McGraw-Hill Ryerson Limited LO4

7 Accelerated Depreciation Amortize more in early years Amortize over useful life to residual value Implies more contribution of asset to earning power in early years Declining balance method is typical Copyright © 2013 McGraw-Hill Ryerson Limited LO4

8 Usage Based Depreciation Amortize based on usage of asset Amortize over useful life to residual value Implies contribution to earning power in proportion to output Units-of-production method is a typical form Copyright © 2013 McGraw-Hill Ryerson Limited LO4

9 Depreciation Expense – Journal Entry Dr. Amortization expenseXXX Cr. Accumulated amortization XXX (contra asset—balance sheet) What is the impact of this entry on: ▫The income statement? ▫The balance sheet? Copyright © 2013 McGraw-Hill Ryerson Limited LO4

10 Statement Presentation Depreciation of tangible asset is a contra asset account Amortization of intangible asset is offset against the asset account No cash flow impact Amortization expense disclosed separately Copyright © 2013 McGraw-Hill Ryerson Limited LO4

11 Effects of Deprecation Methods Depreciation methods can have significant effects on yearly reported ▫net income ▫net capital assets ▫total assets Choices affect timing of revenues and expenses but not totals Management might choose depreciation methods that satisfy reporting objectives Copyright © 2013 McGraw-Hill Ryerson Limited LO4

12 Componentization of Assets Items of PPE may be made up of components for which different useful lives/depreciation methods are appropriate IFRS requires components to be accounted for separately Copyright © 2013 McGraw-Hill Ryerson Limited LO4