1. Chapter 12 Capital Assets

2. 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,

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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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 (10000-1750)

13. 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 =

14. 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 =

15. 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

16. 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

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

18. 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