CHAPTER 1 Tools for Business Decision- Making Fifth Canadian Edition Financial Accounting: Prepared By: Debbie Musil Kwantlen Polytechnic University Copyright John Wiley & Sons Canada, Ltd. 1 9

CHAPTER 1 Reporting and Analyzing Long-Lived Assets Study Objectives 1.Determine the cost of property, plant and equipment. 2.Explain and calculate depreciation. 3.Describe other accounting issues related to depreciation. 4.Account for the disposal of property, plant and equipment. 5.Identify the basic accounting issues for intangible assets and goodwill. 6.Illustrate how long-lived assets are reported in the financial statements. 7.Describe the methods for evaluating the use of assets. 9 Copyright John Wiley & Sons Canada, Ltd. 2 9

CHAPTER 1 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 Copyright John Wiley & Sons Canada, Ltd. 3 9

CHAPTER 1 Determining the Cost of Property, Plant and Equipment Record at cost, which includes: – Purchase price, including taxes and duties, less discounts or rebates – Expenditures necessary to bring asset to its intended location and make it ready for its intended use Copyright John Wiley & Sons Canada, Ltd. 4 9

CHAPTER 1 Types of Expenditures Operating expenditures –Benefit only the current period –Immediately charged against revenue as an expense Capital expenditures –Capitalized as an asset –Benefit future periods –Increases a company’s investment in productive activity 9 Copyright John Wiley & Sons Canada, Ltd. 5

CHAPTER 1 Land Cost of land includes – Purchase price – Closing costs such as title and legal fees – Additional costs to prepare land for its intended use (less any proceeds from salvage) Land has an unlimited life, therefore it is not depreciated Copyright John Wiley & Sons Canada, Ltd. 6 9

CHAPTER 1 Land Improvements The costs of structural additions made to land (e.g. paving, fencing) These decline in service potential over time – They are recorded separately from land – Depreciated over their useful lives Copyright John Wiley & Sons Canada, Ltd. 7 9

CHAPTER 1 Buildings All expenditures related to the purchase or construction of a building When a building is purchased such costs include: – Purchase price – Closing costs (legal fees, title, insurance) – Costs required to make building ready for its intended use Copyright John Wiley & Sons Canada, Ltd. 8 9

CHAPTER 1 Buildings (Continued) When a building is constructed, its cost consists of: – Contract price – Architect's fees – Building permits – Excavation cost – Interest costs during construction Copyright John Wiley & Sons Canada, Ltd. 9 9

CHAPTER 1 Equipment Costs include: – Purchase price – Freight charges and insurance during transit paid by the purchaser – Assembling – Installing and testing 9 Copyright John Wiley & Sons Canada, Ltd. 10

CHAPTER 1 Asset Retirement Costs Cost of any obligation to dismantle, remove or restore a long-lived asset when it is retired These costs are estimated in advance and included as part of the cost of the asset 9 Copyright John Wiley & Sons Canada, Ltd. 11

CHAPTER 1 Discussion Question What are some of the expenditures that would be included in the cost of a specialized piece of equipment that a company ordered and had delivered from another country? 9 Copyright John Wiley & Sons Canada, Ltd. 12

CHAPTER 1 Buy or Lease? Advantages of leasing – Reduced risk of obsolescence – 100% financing – Income tax – “Off-balance sheet” financing Terminology – Lessor — owner of asset for lease (e.g., landlord) – Lessee — company leasing asset from owner (e.g., tenant) 9 Copyright John Wiley & Sons Canada, Ltd. 13

CHAPTER 1 Buy or Lease? (Continued) Operating lease – Treated as rental by lessee – Periodic payment (dr. rent expense/cr. cash) Finance lease – Treated as purchase by lessee (dr. asset/cr. liability) – Periodic payment (dr. liability and interest expense/cr. cash) 9 Copyright John Wiley & Sons Canada, Ltd. 14

CHAPTER 1 Depreciation Systematic allocation of the cost of property, plant and equipment over the asset’s useful life A process of cost allocation, not asset valuation Does not use or provide cash to replace the asset 9 Copyright John Wiley & Sons Canada, Ltd. 15

CHAPTER Factors In Calculating Depreciation Copyright John Wiley & Sons Canada, Ltd Illustration 9-2

CHAPTER 1 Depreciation Methods Straight-line – Used by the majority of Canadian publicly- traded companies Diminishing-balance Units-of-production 9 Copyright John Wiley & Sons Canada, Ltd. 17

CHAPTER 1 Example – Depreciation Methods A delivery van was bought on Jan. 1, 2012 Cost $33,000 Estimated residual value $3,000 Estimated useful life (in years) 5 Estimated useful life (in kilometres) 100,000 9 Copyright John Wiley & Sons Canada, Ltd. 18

CHAPTER Depreciation is constant for each year of the asset's useful life Straight-Line Method Copyright John Wiley & Sons Canada, Ltd Illustration 9-3

CHAPTER 1 Diminishing-Balance Method Produces a decreasing annual depreciation expense over an asset’s useful life – Depreciation is calculated based on the asset’s carrying amount, which diminishes each year as accumulated depreciation increases Annual depreciation expense is calculated by multiplying the carrying amount by the depreciation rate – Residual value is not included in the calculation Can be applied using different rates – Depreciation rate = Straight-line rate x multiplier 9 Copyright John Wiley & Sons Canada, Ltd. 20

CHAPTER Diminishing-Balance Method (Continued) Copyright John Wiley & Sons Canada, Ltd Illustration 9-5

CHAPTER 1 Units-of-Production Method Useful life is expressed in terms of total units of production or activity expected from the asset – Such as units produced or machine-hours worked Useful for factory machinery, vehicles, airplanes 9 Copyright John Wiley & Sons Canada, Ltd. 22

CHAPTER Units-of-Production Method Copyright John Wiley & Sons Canada, Ltd. 23 9

CHAPTER 1 Discussion Question What would be the best choice of depreciation method for a fleet of company trucks if a company wanted the depreciation expense to track the “wear and tear” of the trucks? 9 Copyright John Wiley & Sons Canada, Ltd. 24

CHAPTER 1 Other Depreciation Issues 9 Copyright John Wiley & Sons Canada, Ltd. 25 Significant components – May be depreciated separately Income tax Impairments – When carrying amount of asset exceeds its recoverable amount Cost vs. revaluation model – Revaluation model allowed under IFRS – Allows revaluation to fair market value

CHAPTER 1 Revising Periodic Depreciation Revisions needed if: – Capital expenditures during useful life – Impairment losses – Change in estimated useful life or residual value – Change in the pattern in which the asset’s economic benefits are consumed Accounted for as a change in estimate – Change made in current and future years, but not to prior periods (prospectively) 9 Copyright John Wiley & Sons Canada, Ltd. 26

CHAPTER 1 Disposals of Property, Plant, and Equipment 1.Update depreciation – Depreciation for the fraction of the year to the date of disposal must be recorded 2.Calculate carrying amount – Carrying amount = Cost – Accumulated depreciation 3.Calculate gain or loss – Proceeds – carrying amount = gain (loss) Copyright John Wiley & Sons Canada, Ltd Proceeds > carrying amount = Gain (Cr.) Proceeds < carrying amount = Loss (Dr.)

CHAPTER 1 Disposals of Property, Plant, and Equipment 4.Record disposal – Remove cost of asset and accumulated depreciation. Record proceeds (if any) and gain or loss on disposition (if any) 9 Copyright John Wiley & Sons Canada, Ltd. 28 Cash xxx Accumulated Depreciation xxx Asset xxx Gain on Disposal xxx

CHAPTER 1 Intangible Assets and Goodwill Do not have physical substance Rights, privileges and/or competitive advantages – For example, intellectual property in a production process Must be identifiable – either: – Can be separated from company and sold; or – Based on contractual or legal rights 9 Copyright John Wiley & Sons Canada, Ltd. 29

CHAPTER 1 Accounting for Intangible Assets Accounting for intangible assets parallels accounting for tangible assets – Recorded at cost including all costs to make asset ready for use If intangible asset has a finite (limited) life, its cost must be systematically allocated over its useful life – For intangible assets, this is referred to as amortization rather than depreciation Intangible assets with an indefinite (unlimited) life are not amortized 9 Copyright John Wiley & Sons Canada, Ltd. 30

CHAPTER 1 Amortization for Intangibles Amortize over shorter of – Estimated useful life – Legal life Test for impairment 9 Copyright John Wiley & Sons Canada, Ltd. 31

CHAPTER 1 Intangibles with Finite Lives Patents – Exclusive right to produce for 20 years Research and development costs – All research costs are expensed – Development costs are capitalized only if associated with an identifiable, feasible product Copyrights © – Protection for the life of the creator + 50 years 9 Copyright John Wiley & Sons Canada, Ltd. 32

CHAPTER 1 Intangibles with Indefinite Lives Trademarks and trade names ™® – Word, jingle, symbol that distinguishes business Franchises – Contractual agreement to sell products or services Licences – Operating rights 9 Copyright John Wiley & Sons Canada, Ltd. 33

CHAPTER 1 Goodwill Asset representing future economic benefits arising from the purchase of a business – Excess of cost over fair market value of net assets (assets less liabilities) acquired – Represents the extra value relating to a business when it is purchased – Only identified with the business as a whole Not amortized, but subject to an annual test for impairment 9 Copyright John Wiley & Sons Canada, Ltd. 34

CHAPTER 1 Presentation of Long-Lived Assets Statement of Financial Position – Reported as Property, Plant and Equipment Intangible Assets Goodwill – Disclose cost and accumulated depreciation (amortization) of each major class of assets Either in statement or in notes – IFRS also requires additional disclosures 9 Copyright John Wiley & Sons Canada, Ltd. 35

CHAPTER 1 Presentation of Long-Lived Assets Income Statement – Depreciation expense, gains and losses on disposal and impairment losses are included in the operating section Statement of Cash Flows – Cash flows from the purchase and sale of long- lived assets are reported in the investing section 9 Copyright John Wiley & Sons Canada, Ltd. 36

CHAPTER 1 Return on Assets Measures overall profitability 9 Copyright John Wiley & Sons Canada, Ltd. 37 Return on Assets = Profit. Average Total Assets Higher is better

CHAPTER 1 Asset Turnover Measures how efficiently a company uses its assets 9 Copyright John Wiley & Sons Canada, Ltd. 38 Asset Turnover = Net Sales Average Total Assets Higher is better

CHAPTER 1 Profit Margin Revisited Together, profit margin and asset turnover explain the return on assets ratio: 9 Copyright John Wiley & Sons Canada, Ltd. 39 Profit x Asset = Return on Margin Turnover Assets

CHAPTER Comparing IFRS and ASPE Copyright John Wiley & Sons Canada, Ltd. 40 9

CHAPTER Comparing IFRS and ASPE (Continued) Copyright John Wiley & Sons Canada, Ltd. 41 9

CHAPTER 1 Copyright Notice Copyright © 2012 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. Copyright John Wiley & Sons Canada, Ltd. 42 9