1. FINANCIAL ACCOUNTING A USER PERSPECTIVE
Hoskin • Fizzell • Davidson
Second Canadian Edition

2. Capital Assets
Chapter Eight

3. Capital Asset Recognition
Capital assets
Used to generate revenue over several periods in the future
Used until replaced with a new asset
Can have residual (or resale) value

4. Capital Asset Valuation
Historical cost
Original cost of the asset
Expensed (amortized) over the period used

5. Capital Asset Valuation
Gain or loss on sale
Recognized only when sold
Difference between proceeds of the sale and the net book value
Net book value (or carrying value)
Original cost less amortization

6. Capital Asset Valuation
Market value
Replacement cost
Amount that would be needed to acquire an equivalent asset
Net realizable value
Amount that could be received by converting the asset to cash

7. Capital Asset Valuation
Canadian practice
Uses historical cost
Amortized over the period of use
Maximum of 40 years
Market value changes generally not recognized

8. Capitalizable Costs Costs to acquire and prepare the asset for use
Purchase price (less any discounts)
Installation costs
Transportation costs
Legal costs
Direct taxes

9. Basket Purchases Several assets acquires in one transaction
Price paid is divided between the assets on the basis of their relative fair values at the time of acquisition

10. Basket Purchases
Timberland Example

11. Interest Capitalization
Companies often borrow money to finance a capital asset
Interest paid on borrowed money
Capitalized when it is included in the capital asset account rather than being expensed

12. Amortization (or Depreciation)
Method for allocating the cost of capital assets to the periods in which the benefits from the assets are received (the useful life)
Does not refer to the value of the asset
Follows the matching concept

13. Amortization Methods Straight-line method
Accelerated or diminishing balance method
Decelerated method
Unit of production method

14. Amortization Methods
Asset Carrying Value
Dol
lars

15. Amortization Methods
Amortization Expense Do l
lars

16. Straight-Line Method
Allocates the cost evenly over the life of the asset
Estimates needed for
Useful life
Residual value

17. Straight-Line Method Assumptions: Original Cost $10,000 Estimated
Residual Value $1,000
Useful Life 5 years

18. Straight-Line Method - = - = = Original Cost Residual Value
Amortization Expense =
Useful Life -
$10,000
$1,000 =
5 years =
$1,800 per year

19. Straight-Line Method
Amortization Schedule

20. Accelerated Methods Amortization Carrying value decreases each year
Multiply the carrying value of the asset by a fixed percentage
Carrying value decreases each year
Amortization expenses decreases each year

21. Accelerated Methods Percentage rates Double declining balance method
Lower when asset has longer life
Double declining balance method
Percentage is double the straight-line rate
Residual value
Not used for computations
Serves as a constraint

22. Double Declining Balance Method
Assumptions:
Original Cost $10,000
Estimated
Residual Value $1,000
Useful Life 5 years
200% Declining Balance Method

23. Double Declining Balance Method
Calculation:
DB rate = DB% x SL rate
= 200% x 1/n
= 200% x 1/5
= 40%

24. Double Declining Balance Method
Amortization Schedule

25. Production Method Assumptions
Benefits derived are related to the output or use of an asset
Requires that the useful life can be expressed as units of output

26. Production Method Assumptions: Original Cost $10,000
Estimated Residual Value $1,000
Estimated Usage

27. Production Method - = - = = Cost Residual Value
Amortization Expense per Unit =
Estimated Total Units of Output -
$10,000
$1,000 =
20,000 units =
$0.45 per unit

28. Production Methods
Amortization Schedule

29. Recording Amortization Expense
All amortization methods:
SE-Amortization expense XX
XA-Accumulated amortization XX

30. Corporate Income Taxes
Revenue Canada
Amortization expense is allowed to be deducted to calculate accounting income
Capital cost allowance (CCA) instead must be used to calculate taxable income

31. Corporate Income Taxes
May result in a temporary difference between Accounting income and taxable income
Result is a future tax asset or liability (formerly referred to as deferred tax)

32. Capital Cost Allowance (CCA)
Capital assets are grouped into classes and assigned a maximum rate
Vehicles: Class 10: rate 30%
Equipment: Class 8: rate 20%

33. Capital Cost Allowance (CCA)
Companies may deduct any part of the undepreciated capital costs (UCC) in the class up to the stated maximum
Exception:
Year of acquisition: 50% of normal amount

34. Capital Cost Allowance (CCA)
Central Corp. purchases new equipment (Class 8) at a cost of $20,000
CCA
Year 1: 50% x $20,000 x 20% = $2,000
Year 2: 20% x ($20,000-$2,000)= $3,600
Year 3: 20% x ($20,000-$2,000-$3,600) = $2,880

35. Capital Cost Allowance (CCA)
Journal entry:
SE-Tax expense 11,460
A-Future tax asset*
L-Income taxes payable 11,550
*(Future tax liability if a credit balance)

36. Changes in Amortization Estimates and Methods
Estimates of useful life and residual value may change over time
Amortization may change as a result

37. Changes in Amortization Estimates and Methods
Straight-Line Method Assumptions
Original Cost $10,000
Residual Value $1,000
Useful Life 5 years
Changes in Year 4 (Estimations)
Remaining Useful Life 3 years
Residual Value $ 400

38. Changes in Amortization Estimates and Methods
Remaining Book Value -
Residual Value
Amortization Expense =
Useful Life -
$4,600
$400 =
3 years =
$1,400 per year

39. Changes in Amortization Estimates and Methods
Amortization Schedule

40. Sale of Capital Assets
Original cost and accumulated amortization removed from accounts
Gain or loss: difference between cash received and book value
A-Cash 1,200
XA-Accumulated amortization 9,000
A-Property, plant and equipment 10,000
SE-Gain on sale of PP&E

41. Disposal of Capital Assets
If assets are disposed of and no cash is received
XA-Accumulated amortization 9,000
SE-Loss on disposal of PP&E 1,000
A-Property, plant and equipment 10,000

42. Writedown of Capital Assets
If future recoverable amount of a capital asset declines below its carrying value
SE-Loss due to damage to asset 1,000
XA-Accumulated amortization 1,000

43. Natural Resources
Capitalizing the costs implies that they have future value
Example: oil exploration
Exploration costs choices
Full costing method
Successful efforts method

44. Intangible Assets
Intangible assets have probable future value but no physical form
Guidelines:
If developed internally, expense as incurred
If purchased, can be capitalized

45. Intangible Assets Estimate useful life and residual value (if any)
Use straight-line method to amortize
SE-Amortization expense XX
A-Patents XX

46. Intangible Assets Advertising Patents, Trademarks, Copyrights Goodwill
Generally expensed as incurred
Patents, Trademarks, Copyrights
Legal life is the maximum for amortizing
Goodwill
Capitalize and amortize if purchased

47. Return on Assets ROA Net income before interest = Average total assets
Net income + [Interest expense x (1-Tax rate)] =
Average total assets