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Chapter 10

Long-Term Assets

QuestionAnswer
The Production Method is based on the assumption that depreciation is solely the result of use and that the passage of time plays no role in the process.
When is the production method appropriate to use? When a company has widely fluctuating rates of production. For example, carpet mills often close during the first two weeks in July but run double shifts in September. With the production method, depreciation would be in direct relation to a mill's output
Under the production method, depreciation is calculated as: depreciation expense= cost-residual value/estimated units of useful life
In considering whether to use the production method it is important to keep the following points in mind: it must be possbile to estimate with reasonable accuracy the output of an asset over its useful life; the unit used to measure the estimated useful life of an asset must be appropriate for the asset
Accelerated method: results in relatively large amounts of depreciation in the early years of an asset's life and smaller amounts in later years; depreciation charges will be higher in years when revenue generation from the asset is highest
What assumption is the accelerated method based off? that many plant assets are most efficient when new and so provide the greatest benefits in their first years
When is using the accelerated method appropriate? When fast-changing technologies often cause equipment to become obsolete and lose service value rapidly; repair expense is likely to increase as an asset ages making depreciation and repair expense fairly constant over the years
The declining balance method: is the most common accelerated method of depreciation and with this method depreciation is computed by applying a fixed rate to the declining carrying value of a long-term asset; results in higher depreciation charges in the early years of an asset's life
double-declining-balance method the most common rate that is a percentage equal to twice the straight-line depreciation expense
The double-declining-balance method is the only method presented here in which the residual value is not deducted before calculating _______ depreciation
annual depreciation rate equals: % of useful life/estimated useful life
group depreciation: large companies group similar assets, such as machines, to calculate depreciation; the estimated useful life of an asset is the average length of time assets of the same type are expected to last; 67% of large bus. use this method
depreciation for partial years: some companies compute depreciation to the nearest month; others use the half year convention, in which 1/2 yr of depreciation is taken in the year the asset is purchased and 1/2 year is taken in the last year of the asset's life
Revision of depreciation rates: the periodic depreciation charge is seldom precise and may need to be revised so that the periodic depreciation expense increases or decreases over the asset's remaining life
special rules for tax purposes: Congress has revised the federal income tax law to encourage bus. to invest in new plant and equipment; not usually accepted for financial reporting because the periods in which deductions may be taken are shorter than asset's life
A change in the federal income tax law- the result of the Economic Stimulus Act of 2008- allows a small company to expense the first $250,000 of equipment expenditures rather than record them as assets and depreciate them over their useful life. Also, for assets subject to deprec. there is a bonus first-year deduction
When plant assets, like buildings and equipment, are no longer useful because they have physically deterioted or become obsolete a company can: discard them, trade them in on the purchase of a new asset, or sell them
If the residual value is zero, the carrying value of a fully depreciated asset is equal to zero; when the asset is discarded, no gain or loss results; for assets with a carrying value, however, a loss equal to the carrying value should be recorded
When a company disposes of an asset, it must bring the depreciation up to date and remove all evidence of ownership of the asset, including the contra account accumulated depreciation; debit accumulated depreciation machinery and loss on disposal of machinery, credit machinery
When an asset is discarded or sold for cash, the gain or loss equals cash received minus the carrying value
Plant assets sold for cash: the receipt of cash should be recorded
Natural Resources are recorded at.... acquisition cost, which may include some costs of development; as these resources are converted to inventory, their asset accounts must be proportionally reduced
depletion refers not only to the exhaustion of a natural resource but also to the proportional allocation of the cost of a natural resource to the units extracted
depletion cost per unit= cost-residual value/estimated number of units
A company may abandon equipment that is still in good working condition because... of the expense involved in dismantling the equipment and moving it to another site
The extraction of natural resources generally requires... special on-site buildings and equipment. The useful life of these plant assets may be longer than the estimated time it will take to deplete the resources. In this case, they should be depreciated on the same basis of depletion
The costs of exploring and developing oil and gas resources can be accounted for under one of two methods: successful efforts or full costing; the financial accounting standards board permits the use of either method
Successful Efforts Accounting: the cost of successful exploration is a cost of the resource. It should be recorded as an asset and depleted over the resource's estimated life. The cost of an unsuccessful exploration is written off immediately as a loss
Successful efforts accounting is considered to be... a conservative method and is used by most large oil companies because of the immediate write-offs
Full costing method example: small, independent oil companies argue that the cost of dry wells is part of the overall cost of the systematic development of an oil field and is thus a cost of producing wells, this is an example of full costing method
full costing method definition: all costs, including the cost of dry wells, are recorded as assets and depleted over the estimated life of the resources. This method tends to improve a company's earnings performance in its early years
Intangible Assets: An intangible asset is both long-term and nonphysical and its values come from the long-term rights it affords its owners
Are accounts receivable and certain prepaid expenses considered intangible assets? No, because they are short-term
The purchase of an intangible asset is a special kind what expenditure? capital and are accounted for at the amount that a company paid for them
A company should only include intangible assets on its balance sheet if... it purchased them from another party at a price established in the marketplace since some intangible assets are acquired by little or no cost
When a company develops its intangible assets it should the record the costs of development as what? an expense
What is the useful life of an intangible asset? the period over which the asset is expected to contribute to the company's future cash flows; its useful life may be definite or indefinite
Definite useful life: is subject to legal limit or can be reasonably estimated. Examples, patents, copyrights, and leaseholds and are often less than their legal limits. The cost should be allocated to expense through periodic amoratization
Indefinite Useful Life: not limited by legal, regulatory, contractual, competitive, economic, or other factors. They may not last forever and can include trademarks and brands, can last as long as the company is successful in using them. Are not amoratized
All intangible assets, whether definite or indefinite are subject to an annual what? impairment test to determine if the assets justify their value on the balance sheet. If they have lost some or all of their value in producing future cash flows should be written down to fair value or zero
The amount of the write-down is shown on the income statement... as an impairment charge (deduction) in determining income from operations
The Financial Accounting Standards Board requires that R&D costs be charged to what? to expense in the period in which they incurred; reasoning is that it is too hard to trace specific costs to specific profitable developments. Also, these costs are continuous and neccessary for success of a bus. and should be treated as a current expense
Costs that companies incur in developing computer software for sale or lease or for their own internal use are considered what type of costs? R&D until the product has proved feasible; costs incurred before that point should be charged to expense as they are incurred; product is deemed feasible when a detailed working program has been designed; then the costs are recorded as assets
All software production costs are recorded as.... assets once a program has been completed and are amoratized over the software's economic life, using the straight line method; if amount cannot be realized the asset is written down to the amount expected to be realized
Goodwill refers to a company's good reputation; from an acct. standpoint goodwill exists when the purchaser pays more for a bus. than the fair market value of the businesses' net assets; most bus. are worth more as going concerns than as collection of assets
Goodwill reflects customer satisfaction, good management, manufacturing efficiency, the advantages of having a monopoly, good locations, good employee relations
FASB requires that purchased goodwill be reported as... a seperate line item on the b/s and that it be reviewed annually for impairment; if fair value of goodwill is less than its carrying value, it is considered impaired; in that case it is reduced to fair value and its impairment charge is reported on i/s
A company should only record goodwill when... it acquires a controlling interest in another bus.
Where is a good place to study a company's investing activities? its statements of cash flow and in the disclosures in the notes to the financial statements
free cash flow not a financial ratio; is an important measure of a company's ability to finance long-term assets; amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level
free cash flow commitments: current or continuing operations, interest, income taxes, dividends, and net capital expenditures (purchases of plant assets minus sales of plant assets)
IF a company fails to pay for current or continuing operations, interest, and income taxes, what will happen? its creditors or the gov can take legal action; payment of dividends is not required but it represents a committment to stockholders. If they are reduced or eliminated stockholders will be unhappy and price of a company's stock will fall
what does a positive free cash flow mean? a company has met all its cash committments and has cash available to reduce debt or to expand operations
what does a negative free cash flow mean? a company will have to sell its investments, borrow money, or issue stock to continue at its planned level; if its free cash flow remains negative for several years, a company may not be able to raise cash by issuing stock or bonds
the equation for free cash flow free cash flow=net cash flows from operating activities-dividends-purchases of plant assets+sales of plant assets
To avoid fradulent reporting of long-term assets, a company's management must apply accrual accounting in resolving properly two important issues: the amount of the total cost of a long-term asset to allocate to expense in the current period; the amount to retain on the balance sheet as an asset
Management must answer these four important questions about the acquisition use, and disposal of long-term assets: 1) how is the cost of the long term asset determined? 2)how should the expired portion of the cost of the asset be allocated against revenue over time 3) how should repairs and additions be treated? 4) how should disposal be recorded?
Management's answers to the four questions on acquisition can be found where? in the company's annual reports under management discussions and analysis and in the notes to the financial statements
Created by: krystalamber04