1 Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso, Trenholm KIMMEL

2 Chapter 9 Reporting and Analysing Long-Lived Assets After studying Chapter 9, you should be able to: 1.Describe how the cost principle applies to tangible capital assets. 2.Explain the concept of amortization. 3.Compute periodic amortization using the straight-line method, and contrast its expense pattern with those of other methods. 4.Describe the procedure for revising periodic amortization.

3 After studying Chapter 9, you should be able to: 5.Explain how to account for the disposal of tangible capital assets. 6.Describe methods for evaluating the use of tangible capital assets. 7.Identify the basic issues related to reporting intangible assets. 8.Indicate how capital assets are reported on the balance sheet. Chapter 9 Reporting and Analysing Long-Lived Assets

4 Capital Assets +Capital assets are long-lived assets used in the operation of a business, not intended for sale to customers +Capital assets are subdivided into two classes +Tangible (with physical substance +Intangible (without physical substance)

5 Tangible Capital Assets +Property, plant, and equipment +Land +Land improvements +Buildings +Equipment +Natural resources +Timber +Oil and gas +Mineral deposits

6 Tangible Capital Assets +Record at cost (cost principle) +Cost consists of all expenditures necessary to acquire asset and make it ready for its intended use +Cost is measured by +Cash paid in a cash transaction +Cash equivalent price paid when noncash assets are used in payment 1.Fair market value of the asset given up, or 2.If this is not determinable, fair market value of the asset received

7 +Cost of land includes +Cash purchase price +Closing costs such as title and legal fees +Real estate broker’s commission, if paid by purchaser +Accrued property taxes and other liens on the land assumed by the purchaser Land

8 Land Improvements +Cost of land improvements includes +All expenditures necessary to make the improvements ready for their intended use

9 Buildings + All necessary expenditures relating to the purchase or construction of a building + When a building is purchased such costs include +Purchase price +Closing costs (legal fees, title, insurance) +Real estate broker's commissions, if paid by purchaser

10 Buildings + When a building is constructed, its cost consists of +Contract price +Architect's fees +Building permits +Excavation cost +Interest costs during construction

11 Equipment + Purchase price + Provincial sales tax + Freight charges and insurance during transit paid by the purchaser + Expenditures required in assembling + Installing and testing the unit

12 + Natural resources, frequently called wasting assets, are +Physically extracted in operation +Replaceable by an act of nature Natural Resources

13 +Advantages of leasing vs. purchasing +Reduced risk of obsolescence +Little or no down payment +Shared tax advantages +Assets and liabilities not reported (off balance sheet financing) To Buy or To Lease?

14 Amortizable Assets +Revenue producing ability of an asset declines during its useful life because of +Wear and tear +Obsolescence

15 Amortization +Allocating to expense the cost of a capital asset over its useful life in a rational and systematic manner, in accordance with matching principle +Process of cost allocation, not asset valuation +Not a cash fund

16 Amortization Exception: Land +Do not amortize land since usefulness and revenue producing ability generally remain intact, or increase

17 Factors in Computing Amortization Illustration 9-6

18 +Straight-line +Declining-balance +Units-of-activity Amortization Methods

19 Illustration 9-7 Straight-line Amortization

20 Straight-line Method +Amortization is constant for each year of the asset's useful life Illustration 9-8

21 Declining-Balance Method +Accelerated methods result in more amortization in early years and less in later years Illustration 9-9

22 Units-of-Activity Method +Useful life is expressed in terms of total units of production or activity expected from the asset Illustration 9-10

23 Amortization and Income Taxes +Required to use declining balance method (called capital cost allowance) on corporate income tax return, with specified rates, regardless of which method chosen for financial reporting +Choose method for financial reporting based on GAAP +Income tax regulations do not adhere to GAAP

24 Revising Periodic Amortization +Revisions made in current and future years but not to prior periods Revised amortization expense = Net book value at time of revision – revised salvage value Remaining useful life What is effect of extending an asset's estimated life on statement of earnings? In total over life of asset?

25 Types of Expenditures +Revenue (operating) expenditure +Current period expenditure +Immediately charged against revenue as an expense + Capital expenditure +Capitalized as an asset +Increases the company’s investment in productive activity

26 Types of Expenditures +Two criteria apply in determining revenue or capital expenditure +Frequency of cost--one time or recurring +Benefit period--the life of the asset or 1 year

27 Expenditures During Useful Life +Ordinary repairs +Additions and improvements

28 Ordinary Repairs +Expenditures to maintain operating efficiency and expected productive life of the asset +Usually small in amount and occur frequently throughout service life +Revenue (operating) expenditures

29 Additions and Improvements +Costs incurred to increase +Operating efficiency +Productive capacity +Expected useful life of the tangible capital asset +Usually material in amount and occur infrequently +Capital expenditures

30 +Permanent decline in the market value of an asset +Write down to the new market value during the year in which the decline occurs Impairment

31 Tangible Capital Asset Disposals Amortization for the fraction of the year to the date of disposal must be recorded Amortization expensexxx Accumulated amortization xxx Compute net book value Net book value = Cost - accumulated amortization 1 2

32 Tangible Capital Asset Disposals Compare net book value to sale proceeds Proceeds > Net book value = gain (cr.) Proceeds < Net book value = loss (dr.) Record disposition, removing cost of asset and accumulated amortization, and record proceeds (if any) and gain or loss on disposition (if any) 3 4 Cashxxx Accumulated amortizationxxx Capital assetxxx Gain on disposalxxx

33 +Average useful life +Average age of property, plant, and equipment +Asset turnover ratio Analysing Tangible Capital Assets

34 Average Useful Life Average useful life = Average cost of property, plant, and equipment Amortization expense

35 +If, as most do, companies use straight-line amortization for financial reporting, Average Age Average age of property, plant, and equipment = Accumulated amortization Amortization expense

36 +Two ways a company can increase its return on assets +Increase profit per sale (profit margin ratio) +Increase volume of sales (asset turnover ratio) Asset Turnover Asset turnover = Net sales Average total assets

37 Intangible Capital Assets +Rights, privileges +Competitive advantages that result from ownership of long-lived assets that do not possess physical substance

38 Accounting for Intangibles +Accounting for intangible capital assets parallels the accounting for tangible capital assets +Intangible assets are +Recorded at cost +Amortized over useful life in a rational and systematic manner +At disposal, book value is eliminated and gain or loss, if any, is recorded

39 +Allocation of the cost of an intangible asset to expense over the shorter of +Useful (economic) life +Legal life +40 years +Straight-line method of amortization used Amortization

40 Types of Intangible Assets +Patents +Research and Development Costs +Copyrights +Trademark and Trade Names +Franchises and Licenses +Goodwill

41 Patents +Exclusive right to manufacture, sell or control granted for 20 years +Legal costs of protecting a patent in an infringement suit are added to the Patent account and amortized over the remaining life of the patent

42 +Research costs–record as an expense when incurred +Development costs–capitalize if associated with an identifiable, feasible product. Otherwise, expense Research and Development Costs

43 +Copyrights are granted by the federal government giving the owner the exclusive right to reproduce and sell artistic or published work +Copyrights extend for the life of the creator plus 50 years Copyrights

Trade Marks/Names +Word, phrase, jingle or symbol that distinguishes or identifies a particular enterprise or product

45 Franchises +Contractual agreement under which the franchiser grants the franchisee the right +To sell certain products +To render specific services or to use certain trademarks or trade names, usually within a designated geographic area

46 Licenses +Operating rights permit the enterprise to use public property in performing its service (i.e. the use of airwaves for radio or TV broadcasting)

47 Goodwill +Goodwill represents favourable attributes that relate to a business enterprise +Record only in an exchange transaction that involves the purchase of an entire business +Goodwill equals the excess of cost over the fair market value of the net assets (assets less liabilities) acquired

48 Presentation Of Capital Assets +In the balance sheet, property, plant and equipment, natural resources, and intangible assets are often combined under Capital Assets +Disclose balances and accumulated amortization of the major classes of assets +Amortization methods as well as the amount of amortization expense for the period should be disclosed

49 Decision Checkpoints +Is the company’s estimated useful life for amortization reasonable? +Are the company’s capital assets possibly outdated or in need of replacement? +How effective is the company at generating sales from its assets? +Is the company’s amortization of intangibles reasonable? + Average useful life + Average age + Asset turnover ratio

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