1. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Revised by: Carolyn Doering, Huron Heights SS Weygandt · Kieso · Kimmel · Trenholm

2. CAPITAL ASSETS CHAPTER 10

3. Capital assets are long-lived assets that are used in the operations of a business and are not intended for sale to customers. Capital assets are subdivided into two classes: 1. Tangible (with physical substance) 2. Intangible (without physical substance) CAPITAL ASSETS

4. TANGIBLE CAPITAL ASSETS Tangible capital assets include: Property, Plant and Equipment Land Land improvements Buildings Equipment Natural Resources such as mineral deposits, oil and gas reserves, and timber

5. INTANGIBLE CAPITAL ASSETS Intangible capital assets provide future benefits through the special rights and privileges they convey. Examples: Patents, copyrights, sports contracts, and trademarks © 

6. Capital assets are recorded at cost in accordance with the cost principle. Cost consists of all expenditures necessary to 1) acquire the asset and 2) make it ready for its intended use. These costs include purchase price, freight costs, and installation costs. DETERMINING THE COST OF CAPITAL ASSETS

7. Cost is measured by the cash paid in a cash transaction or by the cash equivalent price when non-cash assets are used in payment. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable. MEASUREMENT OF CAPITAL ASSET COST

8. The cost of Land includes: 1. purchase price 2. closing costs such as title and legal fees 3.accrued property taxes and other liens on the land assumed by the purchaser All necessary costs incurred in making land ready for its intended use are debited to the Land account. LANDLAND

9. The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use, such as: 1. parking lots 2. fencing 3. landscaping 4. lighting Lighting Parking Lot LAND IMPROVEMENTS

10. The cost of buildings includes all necessary expenditures relating to the purchase or construction of a building. When a building is purchased, such costs include the purchase price and closing costs. Costs to make the building ready for its intended use consist of expenditures for remodelling and replacing or repairing the roof, floors, wiring, and plumbing. When a new building is constructed, cost consists of the contract price plus payments for architects’ fees, building permits, interest payments during construction, and excavation costs. BUILDINGSBUILDINGS

11. The cost of equipment consists of the cash purchase price, freight charges, and insurance paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing, and testing the unit. EQUIPMENTEQUIPMENT

12. BASKET PURCHASE Allocate cost of a group of assets in proportion to relative fair market values. For example a building and land are usually purchased together; their indivudual costs must be determined

13. Amortization is the process of allocating to expense the cost of a capital asset over its useful (service) life in a rational and systematic manner. Cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle. During an asset’s life, its usefulness may decline because of wear and tear or obsolescence. The net book value may be very different than its market value. Land is the only capital asset that is not amortized. AMORTIZATIONAMORTIZATION

14. FACTORS IN CALCULATING AMORTIZATION Illustration 10-6

15. AMORTIZATION METHODS Three methods of recognizing amortization are: 1. Straight-line, 2. Units of activity, and 3. Declining-balance. Each method is acceptable under generally accepted accounting principles. Management selects the method that is appropriate for their company. Once a method is chosen, it should be applied consistently.

16. STRAIGHT-LINE METHOD

17. Amortization is constant for each year of the asset's useful life

18. DECLINING-BALANCE METHOD The calculation of periodic amortization is based on a declining net book value (cost less accumulated amortization) of the asset. The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Net Book Value (at beginning of year) Straight-line Rate (x declining balance rate multiplier, if any) Amortization Expense

19. DECLINING-BALANCE METHOD Accelerated methods result in more amortization in early years and less in later years

20. UNITS-OF-ACTIVITY METHOD To use the units-of-activity method, 1) the total units of activity for the entire useful life are estimated, 2) the amount is divided into amortizable cost to calculate the amortization cost per unit, and 3) the amortization cost per unit is then applied to the units of activity during the year to calculate the annual amortization. Amortized Cost Total Units of Activity Amortizable Cost per Unit Units of Activity during the Year Amortization Expense Amortizable Cost per Unit

21. UNITS-OF-ACTIVITY METHOD Useful life is expressed in terms of total units of production or activity expected from the asset

22. UNITS OF ACTIVITY METHOD This method is suited to factory machinery where production is measured in units of output or machine hours It can also be used for delivery equipment (km’s driven), or Airplanes (hours in use)

23. AMORTIZATION AND INCOME TAX Income tax regulations require the taxpayer to use the single declining-balance method on their tax return (Capital Cost Allowance) ClassCapital Asset GroupCCA Rate Class 1Buildings4% Class 8Office Equipment20% Class 10Automobiles, Computers30% Class 12Computer Software100% Class 43Manufacturing Equipment30%

24. If annual amortization is inadequate or excessive, a change in the periodic amount should be made. When a change is made, 1. there is no correction of previously recorded amortization expense and 2. amortization expense for current and future years is revised. REVISING PERIODIC AMORTIZATION Revised amortization expense = Net book value at time of revision – revised salvage value Remaining useful life

25. Ordinary repairs are expenditures to maintain the operating efficiency and expected productive life of the capital asset. They are debited to Repairs Expense as incurred and are often referred to as operating expenditures. Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the capital asset. 1. Expenditures are usually material in amount and occur infrequently during the period of ownership. 2. Since additions and improvements increase the company’s investment in productive facilities, they are debits to the capital asset affected, and are referred to as capital expenditures. EXPENDITURES DURING USEFUL LIFE

26. Capital assets may be disposed of by a) retirement b) sale, or c) exchange CAPITAL ASSET DISPOSALS

27. Amortization for the fraction of the year to the date of disposal must be recorded Amortization expensexxx Accumulated amortization xxx Calculate net book value Net book value = Cost - accumulated amortization 1 2

28. 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

29. Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. Natural resources, frequently called wasting assets, have two distinguishing characteristics: 1. They are physically extracted in operations. 2. They are replaceable only by an act of nature. NATURAL RESOURCES

30. The acquisition cost of a natural resource is the cash or cash equivalent price necessary to acquire the resource and prepare it for its intended use. If the resource is already discovered, cost is the price paid for the property. Site Restoration, reforestation and environmental cleanup must also be added in (ie. Clean up costs after completion) ACQUISITION COST

31. AMORTIZATION – Natural Resources The units-of-activity method is generally used to calculate amortization, because periodic amortization generally is a function of the units extracted during the year.

32. ILLUSTRATION 10-23 FORMULA TO CALCULATE AMORTIZATION EXPENSE Amortizable Cost = (Cost – Residual Value + Restoration Costs) Total Estimated Units Amortization Cost per Unit Amortization Cost per Unit Number of Units Extracted and Sold Amortization Expense Eg. Amortization Expense424,000 Accumulated Amortization – Coal Mine384,000 Liability For Restoration 40,000 To record amortization expense on coal deposits.

33. ILLUSTRATION 10-24 STATEMENT PRESENTATION OF AMORTIZATION Accumulated Amortization, a contra asset account, is deducted from the cost of the natural resource in the balance sheet as follows:

34. Intangible assets are rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance. They include patents, copyrights, trademarks, goodwill, etc… INTANGIBLE ASSETS

35. In general, accounting for intangible assets parallels the accounting for capital assets. Intangible assets are: 1. recorded at cost; 2. written off over useful life in a rational and systematic manner; 3. at disposal, net book value is eliminated and gain or loss, if any, is recorded. ACCOUNTING FOR INTANGIBLE ASSETS

36. Amortizable intangible assets Have defined lives Allocation of the cost to expense over the shorter of Useful (economic) life Legal life Straight-line method of amortization is typically used Most companies credit the specific intangible asset instead of an accumulated ammortization account AMORTIZATION

37. UNAMORTIZABLE INTANGIBLE ASSETS Indefinite useful lives Do not amortize Test for impairment (if the fair market value falls below the net book value)

38. TYPES OF INTANGIBLE ASSETS Patents Copyrights Trademarks and Trade Names Franchises and Licenses Goodwill Research and Development Costs

39. 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 Dec 31 Amortization Expense7500 Patents7500 To record patent amortization

40. 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 (legal life), or its useful life – whichever is shorter COPYRIGHTS

41. TRADE MARKS/NAMES Word, phrase, jingle or symbol that distinguishes or identifies a particular enterprise or product If indefinite life, do not amortize. Test for impairment

42. 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 The cost should be recognized Amortize if franchise is granted for a definite period of time Do not amortize if granted for an indefinite period of time or in perpetuity Annual payments called royalties should be recorded as operating expenses

43. 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) Like a franchise if a cost can be identified it should be recognized Ammortize if for a definite period of time

44. GOODWILL Goodwill represents favourable attributes that relate to a business enterprise (eg. exceptional management, desirable location, etc…) Record only in an exchange transaction that involves the purchase of an entire business (otherwise it is too difficult to measure) Goodwill equals the excess of cost over the fair market value of the net assets (assets less liabilities) acquired Goodwill is not amortized as it has an unlimited useful life. It must be tested regularly for impairment.

45. R&D are not intangible assets, but they often lead to patents and copyrights Research costs–record as an expense when incurred Development costs–capitalize if associated with an identifiable, feasible product. Otherwise, expense RESEARCH AND DEVELOPMENT COSTS

46. In the balance sheet, property, plant and equipment, natural resources, and intangible assets are often combined under the heading Capital Assets. There should be disclosure of the balances in the major classes of assets and accumulated amortization of major classes of assets or of assets in total. The amortization methods used should be described and the amount of amortization expense for the period disclosed. FINANCIAL STATEMENT PRESENTATION

47. ASSET TURNOVER RATIO The ratio that shows how efficiently a company uses its assets to generate sales is the asset turnover ratio. Net Average Assets Sales Total Assets Turnover  =

48. RETURN ON ASSETS The ratio that shows the profitability of assets used in the earnings process is the return on assets. It is the amount of net income generated by each dollar invested in assets. Net Average Return on IncomeTotal Assets Assets  =

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