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Review of Chapter 6

Cost of inventory
Account for inventory perpetual, periodic
Costing inventory methods:
Specific ID, Weighted Average, FIFO
Accounting principles: comparability, disclosure
Lower of Cost-and-Net-Realizable Value Rule
Effect of inventory errors
Cost of goods sold model
Ratios: Gross profit percentage and inventory turnover

Review Question #1
Using the information on the overhead projector,
the cost of inventory at July 31, 2014 using
the FIFO method is:
a.
b.
c.
d.

9,500
$10,800
$11,000
$13,400

Property, Plant, and


Equipment, and Intangible
Assets
Chapter 7

Learning Objective 1
Describe the types
of tangible and intangible
assets a business may own

Long-Lived Assets
Asset Account
(Balance Sheet)
Tangible assets
Land

Related Expense Account


(Income Statement)
None

Buildings, Machinery, & Depreciation


Equipment
Furniture & Fixtures
Land Improvements
Intangible assets

Depreciation
Depreciation
Amortization

Learning Objective 2
Measure and account for the cost
of property, plant, and
equipment

7-6

Property, Plant and Equipment


Property, Plant and Equipment such as land, buildings,
machinery and equipment, etc. are held for use in the
business
The cost of these assets is the purchase price plus any
other amount paid to acquire it and make it ready for
use.
Examples of costs are: purchase price less any discount,
freight, taxes, commissions, assembly costs, installation
costs, testing costs, etc.

Example: Determining the Cost of


Land
A business signs a $300,000 note payable
to purchase land for a new store site.
It pays $10,000 in real estate commission,
$8,000 in back property tax, $5,000 for
removal of an old building, a $1,000 survey
fee, and $260,000 to pave the parking lot.
What is the cost of the land?

Determining the Cost of Land


Purchase price of land
Add related costs:
Real estate commission $10,000
Back property tax
8,000
Removal of buildings
5,000
Survey fees
1,000
Total cost of land

$300,000

24,000
$324,000

Lump-Sum (or Basket) Purchases of Assets


When a company purchases a group of assets, they must
identify the cost of each asset using the relative sales
value.
Example:
Company paid $1 million for building and land
Market value of building = $960,000
land
= 240,000
Total market value
$1,200,000

Lump-Sum (or Basket) Purchases of Assets


Allocation:
Building =
Land =
Total cost allocated
Dr Building
Dr Land
Cr
Cash

$1,000,000

1,000,000

Capital Expenditure versus


an Immediate Expense
Does the expenditure increase capacity
or efficiency or extend useful life?

Capital Expenditures:
Record an asset

Expenses:
Record an expense

Capital Expenditure versus


an Immediate Expense
Record an Asset for
Capital Expenditures

Record Repair and


Maintenance Expense

Extraordinary repairs:
Major engine overhaul
Modification of body
for new use of truck
Addition to storage
capacity of truck

Ordinary repairs:
Repair of transmission
or other mechanism
Oil change, lubrication, etc.
Replacement tires, windshield
Paint job

Question #2
Land and building were bought for a total of
$485,000. The market value for the land was
$175,000 and $325,000 for the building. What
amounts should be recorded for them?
Land
Building
a. $175,000
$325,000
b. $160,000
$325,000
c. $175,000
$310,000
d. $169,750
$315,250

Learning Objective 3
Calculate and record
depreciation on
property, plant, and
equipment

Depreciation
Depreciation allocates the cost of the property, plant and
equipment to expense over future periods
Limited life caused by physical wear and tear and
obsolescence (except for land)
The cost of using it is recorded in the same period the
revenue is earned
An adjusting entry is prepared using an estimate

Depreciation - Terminology
Cost all costs incurred to get the asset ready for use
Accumulated depreciation depreciation expensed
over the accounting periods
Estimated useful life the length of service the
business expects from the asset
Estimated residual value it is the expected cash
value of an asset at the end of its useful life

Depreciation Methods
Straight-line (SL)
Units-of-production (UOP)
Diminishing balance or
Double-diminishing-balance (DDB)

Depreciation Methods - Example


Cost of delivery van $55,000
Estimated residual value
5,000
Estimated useful life
4 years
Units of production
200,000 km
Actual kms driven:
Yr. 1= 52,000 Yr. 3 = 47,000
Yr. 2 = 48,000 Yr. 4 = 53,000

Straight-Line Method
(Cost Residual value) Years of useful life
($55,000 $5,000) 4 = $12,500
Year 1 depreciation:
Year 2 depreciation:
Year 3 depreciation:
Year 4 depreciation:
Total depreciation:

$12,500
12,500
12,500
12,500
$50,000

Units-of-Production Method

Year 1: 52,000 km $0.25 = $13,000


Year 2: 48,000 km $0.25 = 12,000
Year 3: 47,000 km $0.25 = 11,750
Year 4: 53,000 km $0.25 = 13,250

Double-Diminishing-Balance
Method
Straight-line rate per year: 100% 4 = 25%
Double-diminishing balance:
2 times the straight-line rate = 50%
Year 1: 55,000 0.50 =
$27,500
Year 2: 55,000-27,500 x .50 =
$13,750
Year 3: 55,000-27,500-13,750 x .50 = $6,875
Year 4:
$1,875**
Total accumulated depreciation
=$50,000
**The asset is not depreciated below residual value

Comparing Depreciation Methods


Amount of Depreciation per Year

Year
SL
UOP
DDB
1 $ 12,500 $13,000 $27,500
2
12,500 12,000
13,750
3
12,500 11,750
6,875
4
12,500 13,250
1,875
Total $50,000

$50,000

$50,000

Question #3
On Jan. 1, three years ago, the company bought a
machine for $15,000. The estimated useful
life was 10 years and the residual value was
$3,000. If double diminishing balance is
used, what is the depreciation expense for the
third year?
a. $1,500
b. $1,536

c. $1,920
d. $3,000

Learning Objective 4
Explain additional
depreciation topics in
accounting for long-lived
tangible assets

Depreciation for Partial Years


If a company buys an asset other than at year-end:
1) Compute the depreciation for the year
2) Multiply by the fraction of the year you held the
asset

Depreciation for Partial Years


Suppose a business purchases
a building on April 1 for $500,000 with an
estimated life of 20 years and an estimated
residual value of $80,000.
What is the current years depreciation
using the straight-line method?

Depreciation for Partial Years


Full-year depreciation:
($500,000 $80,000) 20 = $21,000
Partial-year depreciation:
$21,000 9/12 = $15,750

Changing the Useful Life


of a Depreciable Asset
Assume an asset cost of $40,000, an eight-year
useful life with no residual value, and
the straight-line method.
$40,000 8 = $5,000 depreciation per year
What is the carrying amount after two years?
$40,000 $10,000 = $30,000

Changing the Useful Life


of a Depreciable Asset
Management believes the asset will remain
useful for an additional ten years.
$30,000 10 = $3,000
(new depreciation per year)

Fully Depreciated Assets


An asset can be used after it is fully depreciated.
The asset and its depreciation account
remain in the ledger with no
additional depreciation entries.

Derecognition of Property,Plant
and Equipment
Derecognition is used to refer to property, plant
and equipment that is either no longer useful or
it is sold
If assets are junked before being full
depreciated, the company incurs a loss on the
disposal
Before accounting for the derecognition, bring
the depreciation up to date

Derecognition of Property,Plant
and Equipment
Example: A company disposes of equipment
that cost $8,000. Accumulated depreciation is
$6,000 and the carrying amount is $2,000.
The journal entry is:
Accumulated depreciation 6,000
Loss on disposal
2,000
Equipment

8,000

Accounting for the Sale of Property, Plant


and Equipment
1. Bring the depreciation up to date.
2. Determine the carrying amount and compare with
the selling price.
3. Determine if there is a gain or loss
4. Record the disposal

Selling a Property, Plant &


Equipment: Example
Equipment which cost $10,000 on 1/1/2011
is sold on Sept. 30, 2014 for $5,000.
It has been depreciated on a straight-line
basis over its 10 years estimated useful life.
There is no residual value.

Selling a Property, Plant &


Equipment: Example
Bring the depreciation up to date:
Dr Depreciation expense
750
Cr Accumulated depreciation
750
($1,000 9/12 = $750)

Selling a Property, Plant &


Equipment: Example
What is the accumulated depreciation
on September 30, 2014?
$10,000 10 = $1,000/year
$1,000 3 years = $3,000
$1,000 9/12 = $750
$3,000 + $750 = $3,750

Selling a Property, Plant &


Equipment: Example
Record the sale. What is the gain or loss?
September 30, 2014
Cash
5,000
Accumulated Depreciation
3,750
Loss on Sale of Equipment
1,250
Equipment
To record sale of equipment for $5,000

10,000

Special Issues in Accounting for


Property, Plant & Equipment
Depreciation for Tax Purposes
Depreciating Significant Components
Impairment
Revaluation Model

Depreciation for Tax Purposes


Many businesses use the straight-line method
The Income Tax Act permits taxpayers to use an
accelerated depreciation for tax purposes
A business can use one method for accounting
purposes and another method for tax purposes

Depreciating Significant
Components
IFRS require that significant components of an
item of property, plant and equipment be
depreciated separately

Impairment
At each reporting date, a company should review
its property, plant and equipment to see if an
asset is impaired
Impairment occurs when then the carrying
amount exceeds its recoverable amount ie
obsolescence, physical damage and loss in
market value

Impairment
Loss on impairment
xxx
Accumulated depreciation

xxx

If the situation changes, IFRS does permit a


company to reverse the impairment loss by
writing the asset up to its carrying amount

Revaluation Model
Under the revaluation model, the asset is
recorded at cost when purchased but then
measured at its fair value less any accumulated
depreciation less any accumulated losses
Fair value is the price at which the asset could
be sold

Learning Objective 5
Account for intangible
assets

Intangible Assets

Patents
Copyrights
Trademarks

Franchises
Licences
Goodwill

Intangible Assets
Intangible assets are recorded at acquisition
cost and are often the most valuable assets.
The residual value is often zero.
Intangible assets fall into 2 categories:
1. Intangibles with finite lives amortized
2. Intangibles with indefinite lives not
amortized but checked for impairment

Example: Intangible Assets: Patents


Patents are federal government grants.
They give the holder the right to
produce and sell an invention.
Suppose a company pays $170,000
to acquire a patent on January 1.
The company believes that its
expected useful life is 5 years.

Example: Intangible Assets: Patents


January 1
Patents
Cash
To acquire a patent

170,000

December 31
Amortization Expense
34,000
Accumulated amortization
To amortize the cost of a patent

170,000

34,000

Intangible Assets
Copyrights films, novels, software, etc - extend
50 years beyond the creators life
Tradenames are assets that represent distinctive
identifications of a product or service
Franchises/Licences granted by private business
or government to sell a product or service

Question #4
A company paid $80,000 to acquire a patent, with an
expected useful life of 4 years, on June 30, 2014.The
entry to record amortization expense at Dec. 31/14 is:
a.

Dr Amortization expense 20,000


Cr
Accumulated amortization
b. Dr Amortization expense
10,000
Cr
Accumulated amortization
c. Amortization expense
10,000
Cr
Patent
d. Dr Amortization expense
20,000
Cr
Patent

20,000
10,000
10,000
20,000

Learning Objective 6
Analyze and evaluate a companys
return on assets

7 - 52

Return on Assets (ROA)

Net income
Average total assets

(Beginning total assets + Ending total assets)/2

DuPont Analysis
Net income
Net profit
margin

Net sales

Net sales
Total asset
turnover

Average total
assets

ROA Using DuPont Analysis

Net profit
margin

Total asset
turnover

Return on
assets

Learning Objective 7
Interpret tangible and intangible
asset activities on the
statement of cash flows

Reporting Property, Plant & Equipment


Transactions:
The Cash Flow Statement
The property, plant & equipment transactions that
appear on the cash flow statement are:
Acquisitions and sales of
Property, plant & equipment (investing activities)
Depreciation/Amortization expense
(added to operating activities)

End of Chapter 7

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