1. Chapters 11 and 12 Long-term Operating Assets ACCT-30301

2. 1. Overview of Topic Operational assets ◦ fixed assets, intangibles, and natural resources Characteristics of fixed assets Accounting over life cycle ◦ acquisition costs ———asset goes into operation ———— ◦ depreciation ◦ costs subsequent to acquisition ———asset goes out of operation ———— ◦ disposals and exchanges ACCT-30302

3. 2. Acquisition Cost Historical cost Components of cost ◦ purchase price + all reasonable and necessary costs to prepare asset for intended use ◦ land – closing costs, title search, attorney fees, preparing land for use ◦ building – construction cost, architect fees, contract admin fees, attorney fees ◦ equipment – freight, installation, testing, discounts Example ACCT-30303

4. 2a. Acquisition Cost Self constructed assets ◦ raw materials, labor, overhead ◦ can never exceed price charged by outsider Cash discounts Materiality Deferred payment contract Lump sum purchase Donated assets Asset retirement obligation ACCT-30304

5. 2b. Acquisition Cost Capitalization of interest ◦ when done  for self constructed assets (not land)  assets constructed for you  assets (inventory) constructed as discrete project ◦ amount capitalized  avoidable interest ◦ amount capitalized = WAE x IR  WAE are weighted by months ◦ interest rate used  specific interest rate  weighted average rate ◦ amount capitalized cannot exceed actual interest ◦ interest income ◦ example ACCT-30305

6. 3. Costs Subsequent to Acquisition General concepts ◦ any cost should be capitalized if it  extends the life of the asset, or  improves the asset Recording expenditure ◦ can debit  fixed asset account  accumulated depreciation ◦ can use  substitution approach  new asset approach  reduce accumulated depreciation approach ACCT-30306

7. 3. Costs Subsequent to Acquisition Repairs and maintenance Additions Improvements and replacements Reinstallation or rearrangement Materiality threshold ACCT-30307

8. 4. Disposition of Fixed Assets Sell, retire, or abandonment ◦ accounted for same Accounting 1. Update depreciation to date of disposal 2. Remove original cost of asset and accumulated depreciation from the books 3. Difference between book value of asset and proceeds recorded as gain or loss ACCT-30308

9. 4. Disposition of Fixed Assets Example ◦ On Jan 2, 2013 purchase new asset: cost: $40,000, life: 5 years, no salvage, use SL ◦ On March 29, 2017 sell asset for $9,000 Depr Exp 2,000 Accum Depr2,000 Cash 9,000 Accum Depr 34,000 Gain on Sale 3,000 Equipment40,000 ACCT-30309

10. 5. Exchange of Nonmonetary Assets Appendix A Terms ◦ monetary asset  represent a fixed claim to a specific number of dollars in future (e.g., cash, A/R, securities) ◦ nonmonetary asset  value is capable of changing in number of dollars (e.g., fixed assets, inventory) ◦ boot  money paid or received in an exchange of assets ACCT-303010

11. 5a. Exchange of Nonmonetary Assets Rules General valuation rule ◦ Cost of new asset acquired equals  FMV of asset given up plus boot paid or minus boot received  or, use FMV of asset acquired if more clearly evident ACCT-303011

12. 5b. Exchange of Nonmonetary Assets If exchange lacks commercial substance or FMV not determinable ◦ cost of new asset equals  BV given up plus boot paid or minus boot received ◦ gain not allowed to be recognized (unless boot is received – then partial recognition of gain) commercial substance means ◦ company expects a change in future cash flows as result of exchange ◦ change is significant relative to FMV of assets exchanged Examples ACCT-303012

13. Depreciation ACCT-303013

14. 1. Theory of Depreciation Definition ◦ the systematic and rational allocation of the cost of a fixed asset Depreciation is an allocation method – not a valuation method Justification ◦ matching ◦ fluctuations in market value too difficult to determine ACCT-303014

15. 2. Depreciation Factors Cost – covered in Chapter 10 Salvage value – estimated Useful life ◦ useful life vs. physical life ◦ functional factors  changes in environment, asset inadequate for intended purpose, obsolescence, supersession ◦ physical factors  routine wear and tear, deterioration, effects of continual usage, etc. ACCT-303015

16. 3. Selecting Appropriate Method Factors ◦ expected use, expected obsolescence, expected pattern of decline in usefulness of asset, expected contribution of asset to revenue, etc. Conceptually ◦ method that most clearly reflects net income Practically ◦ method that minimizes bookkeeping expenses ◦ method that reports highest net income Consistency ACCT-303016

17. 4. Depreciation Methods Activity method ◦ can be based on output (e.g., units produced) ◦ can be based on inputs (e.g., operating hours or miles) Depr = Cost – Salvage x Productive Service Exp Life in Units ACCT-303017

18. 4. Depreciation Methods ACCT-303018

19. 4. Depreciation Methods ACCT-303019

20. 4. Depreciation Methods Straight Line ◦ most commonly used method ◦ easy to use ACCT-303020

21. 4. Depreciation Methods ACCT-303021

22. 4. Depreciation Methods Sum-of-the-years’ digits ◦ (cost – savage) x declining fraction ◦ numerator of fraction  years in life of asset in reverse order ◦ denominator of fraction  sum of the years  compute denominator of fraction as n (n + 1) 2 ACCT-303022

23. 4. Depreciation Methods ACCT-303023

24. 4. Depreciation Methods Declining balance ◦ remaining BV x fixed rate ◦ rate is a multiple of the straight line rate  compute straight line rate as: 100% / life in years ◦ rates commonly used: 125%, 150%, 200% ACCT-303024

25. 4. Depreciation Methods ACCT-303025

26. 4. Depreciation Methods Other methods Group and Composite methods Inventory method ◦ sometimes used for large numbers of low cost assets Retirement and Replacement methods ◦ sometimes used if have large number of similar assets replaced on constant schedule ◦ Retirement method  FIFO approach ◦ Replacement method  LIFO approach ACCT-303026

27. 4. Depreciation Methods Partial years ◦ conventions – must be used consistently  half year in first and last years  full year in first year and none in last year  none in first year and full year in last year  nearest month ◦ SYD  prorate 12-month blocks of depreciation between years ◦ DB  use partial year fraction in first year only ◦ Example ACCT-303027

28. 5. Changes in Depreciation Change in accounting estimate ◦ method, salvage, or life Depreciate remaining BV over remaining life Example ◦ Cost = $11,000 ◦ Salvage = $1,000 ◦ Life = 5 years ◦ Date Acquired = January 1, 2012 ACCT-303028

29. 5. Changes in Depreciation SL depreciation: 11,000 – 1,000 / 5 = 2,000 During 2015, changed life from 5 years to 7 New depreciation used for 2015 and forward ACCT-303029 BV on 1/1/2015 Cost $ 11,000 Accum Depr (2000 x 3) $ 6,000 BV $ 5,000 New Depreciation Amount 5,000 - 1000 / 4 = 1,000

30. Chapter 12 Impairments ACCT-303030

31. 7. Impairments An impairment occurs when expected future net cash flows (undiscounted) of an asset are less than the asset’s carrying amount ACCT-303031

32. 7. Impairments Test for impairment ◦ review events for possible impairment ◦ apply recoverability test to determine if impairment has occurred  impairment occurs if sum of expected future net cash flows (undiscounted) is less than asset’s carrying amount ◦ if impairment has occurred  recognize impairment loss for amount by which the carrying amount of the asset exceeds fair value of asset  fair value is market price if active market exists  if no market, use present value of expected future net cash flows ACCT-303032

33. 7. Impairments ◦ if impaired asset is held for use  new cost basis of asset is the reduced carrying amount  depreciation is taken on new cost basis over asset’s remaining useful life  write-ups of asset’s value are not allowed ◦ if impaired asset is intended to be disposed of  reported at the lower-of cost-or-net realizable value  recovery of impairment loss is allowed but write-up cannot exceed carrying amount of asset before impairment ACCT-303033

34. 7. Impairments ACCT-303034