Financial Accounting:: Tools For Business Decision-Making

Financial
Accounting:1
Tools for Business DecisionMaking
Fifth Canadian Edition
Prepared By:
Debbie Musil
Kwantlen Polytechnic
University
Copyright John Wiley & Sons Canada, Ltd.
CHAPTER
C H APT ER
2
Reporting and
1
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.

CHAPTER
Property, Plant, and Equipment

1
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
CHAPTER
Determining the Cost of Property,

Plant and Equipment 1
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
CHAPTER
Types of Expenditures
1
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 companys investment in

productive activity
CHAPTER
Land
1
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
CHAPTER
Land Improvements
1
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
CHAPTER
Buildings
1
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
CHAPTER
Buildings (Continued)
1
When a building is constructed, its cost
consists of:
Contract price
Architect's fees
Building permits
Excavation cost
Interest costs during construction
CHAPTER
Equipment
1
Costs include:
Purchase price
Freight charges and insurance during transit
paid by the purchaser
Assembling
Installing and testing
10
CHAPTER
Asset Retirement Costs

1
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
11
CHAPTER
Discussion Question
1
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?
12
CHAPTER
Buy or Lease?
1
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)
13
CHAPTER
Buy or Lease? (Continued)

1
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)
14
CHAPTER
Depreciation
1
Systematic allocation of the cost of
property, plant and equipment over the
assets useful life
A process of cost allocation, not asset
valuation
Does not use or provide cash to replace
the asset
15
CHAPTER
Factors In Calculating Depreciation

Illustration 9-2
16
CHAPTER
Depreciation Methods
1
Straight-line
Used by the majority of Canadian publiclytraded companies
Diminishing-balance
Units-of-production
17
CHAPTER
Example Depreciation Methods

1
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
18
CHAPTER
Straight-Line Method
Illustration 9-3
Depreciation is constant for each year of the asset's
useful life
19
CHAPTER
Diminishing-Balance Method
1
Produces a decreasing annual depreciation
expense over an assets useful life
Depreciation is calculated based on the assets
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
20
CHAPTER
Diminishing-Balance Method (Continued)

Illustration 9-5
21
CHAPTER
Units-of-Production Method
1
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
22
CHAPTER
Units-of-Production Method
23
CHAPTER
Discussion Question
1
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?
24
CHAPTER
Other Depreciation Issues

1
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
25
CHAPTER
Revising Periodic Depreciation

1
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 assets
economic benefits are consumed
Accounted for as a change in estimate

Change made in current and future years, but
not to prior periods (prospectively)
26
CHAPTER
Disposals of Property, Plant, and

Equipment
1
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)
Proceeds > carrying amount = Gain (Cr.)
Proceeds < carrying amount = Loss (Dr.)
27
CHAPTER
Disposals of Property, Plant, and

Equipment
1
4. Record disposal
Remove cost of asset and accumulated
depreciation. Record proceeds (if any) and
gain or loss on disposition (if any)
Cash
Accumulated Depreciation
Asset
Gain on Disposal
28
xxx
xxx
xxx
xxx
CHAPTER
Intangible Assets and Goodwill

1
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
29
CHAPTER
Accounting for Intangible Assets

1
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
30
CHAPTER
Amortization for Intangibles

1
Amortize over shorter of
Estimated useful life
Legal life
Test for impairment
31
CHAPTER
Intangibles with Finite Lives

1
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
32
CHAPTER
Intangibles with Indefinite Lives

1
Trademarks and trade names
Word, jingle, symbol that distinguishes
business
Franchises
Contractual agreement to sell products or
services
Licences
Operating rights
33
CHAPTER
Goodwill
1
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
34
CHAPTER
Presentation of Long-Lived
Assets
1
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

35
CHAPTER
Presentation of Long-Lived
Assets
1
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 longlived assets are reported in the investing
section
36
CHAPTER
Return on Assets
1
Measures overall profitability
Profit
.
Return on Assets = Average Total
Assets
Higher is better
37
CHAPTER
Asset Turnover
1
Measures how efficiently a company uses
its assets
Asset Turnover =
Net Sales
Average Total
Assets
Higher is better
38
CHAPTER
Profit Margin Revisited

1
Together, profit margin and asset turnover
explain the return on assets ratio:
Profit x Asset
Margin Turnover
39
Return on
Assets
CHAPTER
Comparing IFRS and ASPE
40
CHAPTER
Comparing IFRS and ASPE (Continued)
41
CHAPTER
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.
42
CHAPTER

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Copyright John Wiley & Sons Canada, Ltd.

Determine the cost of property, plant and equipment.

Explain and calculate depreciation.

Describe other accounting issues related to depreciation.

Account for the disposal of property, plant and equipment.

Identify the basic accounting issues for intangible assets and

Illustrate how long-lived assets are reported in the financial

Describe the methods for evaluating the use of assets.

Property, Plant, and Equipment

Are not intended for sale to customers

Provide benefits over many years

Copyright John Wiley & Sons Canada, Ltd.

Determining the Cost of Property,

Copyright John Wiley & Sons Canada, Ltd.

Increases a companys investment in

Copyright John Wiley & Sons Canada, Ltd.

Land has an unlimited life, therefore it is not

Copyright John Wiley & Sons Canada, Ltd.

Depreciated over their useful lives

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Asset Retirement Costs

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Off-balance sheet financing

Copyright John Wiley & Sons Canada, Ltd.

Buy or Lease? (Continued)

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Factors In Calculating Depreciation

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Example Depreciation Methods

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

Annual depreciation expense is calculated by

Can be applied using different rates

Copyright John Wiley & Sons Canada, Ltd.

Diminishing-Balance Method (Continued)

Copyright John Wiley & Sons Canada, Ltd.

Useful for factory machinery, vehicles,

Copyright John Wiley & Sons Canada, Ltd.

Copyright John Wiley & Sons Canada, Ltd.

What would be the best choice of depreciation

Copyright John Wiley & Sons Canada, Ltd.

Other Depreciation Issues

Cost vs. revaluation model

Copyright John Wiley & Sons Canada, Ltd.

Revising Periodic Depreciation

Revisions needed if:

Change in estimated useful life or residual

Accounted for as a change in estimate

Copyright John Wiley & Sons Canada, Ltd.

Disposals of Property, Plant, and

Depreciation for the fraction of the year to the

2. Calculate carrying amount

3. Calculate gain or loss

Copyright John Wiley & Sons Canada, Ltd.

Disposals of Property, Plant, and

Copyright John Wiley & Sons Canada, Ltd.