Reporting and Analysing Long-Lived Assets

CHAPTER

9

Tangible AssetsTangible Assets

• Tangible assetsTangible assets are long-lived assets used in are long-lived assets used in the operation of a business; not intended for the operation of a business; not intended for sale to customers sale to customers

• They are also referred to as: property, plant, They are also referred to as: property, plant, and equipment; fixed assets; and capital and equipment; fixed assets; and capital assetsassets

• The textbook uses the term property, plant, The textbook uses the term property, plant, and equipmentand equipment

Property, Plant, and EquipmentProperty, Plant, and Equipment

Land improvementsLand improvements

BuildingsBuildings

EquipmentEquipment

LandLand

Property, Plant, and EquipmentProperty, Plant, and Equipment

• Record at costRecord at cost——cost principlecost principle• Cost consists of all expenditures necessary to Cost consists of all expenditures necessary to

acquire asset and make it ready for its intended acquire asset and make it ready for its intended useuse

• Cost is measured by:Cost is measured by:– Cash paid in a cash transactionCash paid in a cash transaction– Cash equivalent price paid when noncash Cash equivalent price paid when noncash

assets are used in paymentassets are used in payment• Cash equivalent price is equal to the fair market Cash equivalent price is equal to the fair market

value of the asset given up, or if this is not value of the asset given up, or if this is not determinable, fair market value of the asset determinable, fair market value of the asset receivedreceived

Property, Plant and EquipmentProperty, Plant and Equipment

• Impairment lossImpairment loss– Permanent decline in the market value of an Permanent decline in the market value of an

assetasset

– Write down to the new market value during the Write down to the new market value during the year in which the decline occursyear in which the decline occurs

– Never write up assetNever write up asset

LandLand

• Cost of land Cost of land includesincludes– Purchase pricePurchase price

– Closing costs such Closing costs such as title and legal as title and legal feesfees

Land ImprovementsLand Improvements

• The costs of structural The costs of structural additions made to land additions made to land (e.g. paving, fencing)(e.g. paving, fencing)

• These are recorded These are recorded separately from landseparately from land

• The cost of land The cost of land improvements is improvements is amortized over their amortized over their limited useful liveslimited useful lives

BuildingsBuildings

• All necessary All necessary expenditures relating to expenditures relating to the purchase or the purchase or construction of a building construction of a building

• When a building is When a building is purchased such costs purchased such costs includeinclude – Purchase pricePurchase price– Closing costs (legal fees, Closing costs (legal fees,

title, insurance)title, insurance)

BuildingsBuildings

• When a building is constructed, its cost When a building is constructed, its cost consists of: consists of: – Contract price Contract price

– Architect's feesArchitect's fees

– Building permitsBuilding permits

– Excavation costExcavation cost

– Interest costs during constructionInterest costs during construction

EquipmentEquipment

Costs include:Costs include:• Purchase pricePurchase price• Provincial sales taxProvincial sales tax• Freight charges and Freight charges and

insurance during transit paid insurance during transit paid by the purchaserby the purchaser

• Expenditures required in Expenditures required in assemblingassembling

• Installing and testing the unitInstalling and testing the unit

Amortizable AssetsAmortizable Assets

• Revenue producing ability of Revenue producing ability of an asset declines during its an asset declines during its useful life because of: useful life because of: – Wear and tearWear and tear– ObsolescenceObsolescence

AmortizationAmortization

• Allocating to expense the cost of an asset Allocating to expense the cost of an asset over its useful life in a rational and over its useful life in a rational and systematic manner, in accordance with the systematic manner, in accordance with the matching principlematching principle

• This is a process of cost allocation, This is a process of cost allocation, notnot asset valuationasset valuation

• Not a cash fundNot a cash fundNote: Do not amortize land since its useful Note: Do not amortize land since its useful life is indefinite. In addition, its usefulness life is indefinite. In addition, its usefulness and revenue producing ability generally and revenue producing ability generally remain intact, or increase.remain intact, or increase.

• Straight-lineStraight-line• Declining-balanceDeclining-balance• Units-of-activityUnits-of-activity

Amortization MethodsAmortization Methods

Straight-Line MethodStraight-Line Method

• Salvage valueSalvage value represents the anticipated cash represents the anticipated cash value of the asset at the end of its useful lifevalue of the asset at the end of its useful life

• Useful life is the expected years of service of the Useful life is the expected years of service of the assetasset

• Amortization expense is constant for each year Amortization expense is constant for each year of the asset's useful lifeof the asset's useful life

Amortization is calculated as:Amortization is calculated as:

Cost of the Asset - Salvage ValueCost of the Asset - Salvage Value

Years of Useful LifeYears of Useful Life

Declining-Balance MethodDeclining-Balance Method

• Amortization using this method produces Amortization using this method produces larger amortization expense in earlier yearslarger amortization expense in earlier years

• Amortization is calculated by multiplying the Amortization is calculated by multiplying the asset’s net book value by a multiple of the asset’s net book value by a multiple of the straight-line rate (1 straight-line rate (1 useful life), or other useful life), or other predetermined ratepredetermined rate

Units-of-Activity MethodUnits-of-Activity Method

• Useful life is expressed in terms of total units of Useful life is expressed in terms of total units of production or activity expected from the assetproduction or activity expected from the asset

• Calculation of amortization is:Calculation of amortization is:

Cost of the Asset - Salvage ValueCost of the Asset - Salvage Value Total Estimated Units of OutputTotal Estimated Units of Output

• Units of output can be kilometres driven, units Units of output can be kilometres driven, units produced, etc.produced, etc.

• Amortization expense will vary each year with Amortization expense will vary each year with changes in the level of activitychanges in the level of activity

Amortization and Income TaxesAmortization and Income Taxes

• Declining-balance method (called Declining-balance method (called capital cost capital cost allowanceallowance) is required on corporate income tax ) is required on corporate income tax return, with specified rates, regardless of which return, with specified rates, regardless of which method is chosen for financial reportingmethod is chosen for financial reporting

• Choose method for financial reporting based on Choose method for financial reporting based on GAAPGAAP

• Income tax regulations do Income tax regulations do notnot adhere to GAAPadhere to GAAP

Revising Periodic AmortizationRevising Periodic Amortization

• Revisions made in current and future years but not Revisions made in current and future years but not to prior periodsto prior periods

Revised amortization expense =Revised amortization expense =

Net book value at time of revision – Revised salvage Net book value at time of revision – Revised salvage valuevalue

Remaining useful lifeRemaining useful lifeWhat is the effect of extending an asset's estimated What is the effect of extending an asset's estimated life on the statement of earnings? In total over the life on the statement of earnings? In total over the life of the asset?life of the asset?

Types of ExpendituresTypes of Expenditures

• Operating expendituresOperating expenditures– Current period Current period

expenditureexpenditure– Immediately charged Immediately charged

against revenue as against revenue as an expensean expense

• Capital expendituresCapital expenditures– Capitalized as an Capitalized as an

assetasset– Increases the Increases the

company’s company’s investment in investment in productive activityproductive activity

Types of ExpendituresTypes of Expenditures

Two criteria apply when determining Two criteria apply when determining operating or capital expenditure:operating or capital expenditure:• Frequency of costFrequency of cost—one time or recurring—one time or recurring

• Benefit periodBenefit period—the life of the asset or 1 year—the life of the asset or 1 year

Expenditures During Useful LifeExpenditures During Useful Life

• Ordinary repairsOrdinary repairs• Additions and Additions and

improvementsimprovements

Ordinary RepairsOrdinary Repairs

• Expenditures to maintain operating Expenditures to maintain operating efficiency and expected productive life efficiency and expected productive life of the asset of the asset

• Usually small in amount and occur Usually small in amount and occur frequently throughout service lifefrequently throughout service life

• ExpenseExpense

Additions and ImprovementsAdditions and Improvements

• Costs that are incurred in order to increase:Costs that are incurred in order to increase:– Operating efficiencyOperating efficiency– Productive capacityProductive capacity– Expected useful life of the tangible capital Expected useful life of the tangible capital

assetasset• Usually material in amount and occur Usually material in amount and occur

infrequentlyinfrequently• Capitalize as an asset (capital expenditure)Capitalize as an asset (capital expenditure)

Disposals of Property, Plant, and Disposals of Property, Plant, and EquipmentEquipment

Amortization for the fraction of the year to the Amortization for the fraction of the year to the date of disposal must be recordeddate of disposal must be recorded

Amortization ExpenseAmortization Expense xxxxxx

Accumulated AmortizationAccumulated Amortization xxxxxx

Calculate net book value:Calculate net book value:Net Book Value =Net Book Value = Cost – Accumulated AmortizationCost – Accumulated Amortization

Disposals of Property, Plant, and Disposals of Property, Plant, and EquipmentEquipment

Compare net book value to sale proceedsCompare net book value to sale proceeds

Proceeds > Net book value = gain (Cr.)Proceeds > Net book value = gain (Cr.)

Proceeds < Net book value = loss (Dr.)Proceeds < Net book value = loss (Dr.)

Record disposition, removing cost of asset and Record disposition, removing cost of asset and accumulated amortization, and record proceeds accumulated amortization, and record proceeds (if any) and gain or loss on disposition (if any)(if any) and gain or loss on disposition (if any)

CashCash xxxxxx

Accumulated AmortizationAccumulated Amortization xxxxxx

AssetAsset xxxxxx

Gain on DisposalGain on Disposal xxxxxx

• Rights, privilegesRights, privileges• Competitive advantages that result from Competitive advantages that result from

ownership of long-lived assets that do not ownership of long-lived assets that do not possess physical substancepossess physical substance

Intangible AssetsIntangible Assets

Accounting for IntangiblesAccounting for Intangibles

• Accounting for intangible assets parallels Accounting for intangible assets parallels accounting for tangible assets accounting for tangible assets

• Intangible assets are recorded at cost and upon Intangible assets are recorded at cost and upon disposal the book value is eliminated and any disposal the book value is eliminated and any gain/loss is recordedgain/loss is recorded

Types of Intangible AssetsTypes of Intangible Assets

• Limited livesLimited lives– PatentsPatents

– Research and development costsResearch and development costs

– Copyrights Copyrights ©©• Indefinite livesIndefinite lives

– Trademarks and trade names Trademarks and trade names ™®™®– Franchises and licensesFranchises and licenses

– GoodwillGoodwill

Intangibles with Limited LivesIntangibles with Limited Lives

• PatentsPatents– Exclusive right to produce for 20 yearsExclusive right to produce for 20 years

• Research and development costsResearch and development costs– Research costs: record as an Research costs: record as an expenseexpense when when

incurredincurred– Development costs: Development costs: capitalizecapitalize if associated with if associated with

an identifiable, feasible product. Otherwise, an identifiable, feasible product. Otherwise, expenseexpense

• Copyrights Copyrights ©©– Protection for the life of the creator + 50 yearsProtection for the life of the creator + 50 years

Amortization for IntangiblesAmortization for Intangibles

• Limited lifeLimited life– Straight-line methodStraight-line method

– Allocated over the shorter of a) estimated Allocated over the shorter of a) estimated useful life and b) legal lifeuseful life and b) legal life

– Credit intangible asset account instead of Credit intangible asset account instead of accumulated amortization accountaccumulated amortization account

Intangibles with Indefinite LivesIntangibles with Indefinite Lives

• Trademarks and trade names Trademarks and trade names ™®™®– Word, jingle, symbol that distinguishes businessWord, jingle, symbol that distinguishes business

• FranchisesFranchises– Contractual agreement to sell products or servicesContractual agreement to sell products or services

• LicensesLicenses– Operating rightsOperating rights

• GoodwillGoodwill– Record only in an exchange transactionRecord only in an exchange transaction that involves that involves

purchase of entire businesspurchase of entire business– Excess of cost over fair market value of net assets Excess of cost over fair market value of net assets

(assets less liabilities) acquired(assets less liabilities) acquired

Amortization for IntangiblesAmortization for Intangibles

• Indefinite lifeIndefinite life– Do not amortizeDo not amortize

– Test for impairment at least annuallyTest for impairment at least annually

– Record impairment loss if fair value less than Record impairment loss if fair value less than carrying valuecarrying value

Presentation of Long-Lived AssetsPresentation of Long-Lived Assets

• In the balance sheet, long-lived assets are In the balance sheet, long-lived assets are normally reported under the headings, Property, normally reported under the headings, Property, Plant, and Equipment and Intangible Assets Plant, and Equipment and Intangible Assets

• Disclose balances and accumulated Disclose balances and accumulated amortization of the major classes of assetsamortization of the major classes of assets

• Amortization methodsAmortization methods as well as the amount of as well as the amount of amortization expenseamortization expense for the period should be for the period should be discloseddisclosed

• Any impairment losses should be disclosedAny impairment losses should be disclosed

Analysing AssetsAnalysing Assets

Return on Assets =Return on Assets =Net EarningsNet Earnings

Average Total AssetsAverage Total Assets

Asset Turnover =Asset Turnover =Net SalesNet Sales

Average Total AssetsAverage Total Assets