Chapter 8 Honors Financial Accounting PDF

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Professor Judith Flaxman Chapter Summary that will help on weekly reading assignments, quizzes, and exams. These are very descriptive summaries which include examples of important and difficult concepts....

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Chapter 8 Honors Financial Accounting Long-lived assets ● Noncurrent assets ● Tangible and intangible resources owned by a business and used in its operations over several years ○ Tangible assets - can be touched ■ Land - had an unlimited life ■ Buildings, fixtures, and equipment ● Aka property, plant, and equipment or fixed assets ■ Natural resources ● Timber tracts and silver mines ○ Intangible assets - no physical substance ■ Patents, copyrights, franchises, licenses, trademarks Acquisition Cost: The net cash equivalent amount paid or to be paid for an asset ● Cost principle: all reasonable and necessary expenditures made in acquiring and preparing an asset for use should be recorded as the cost of an asset ○ Include: sales taxes, legal fees, transportation costs, and installation costs ● Expenditures are capitalized - part of total cost of an asset; NOT an expense ○ However, interest charges associated with the purchase are recorded as expenses as incurred ● Example: ○ A list price of $122M, discount of $4M; transportation costs $400k, prepare a new plane $1.6M

○ ○ Assuming they paid cash:

○ Fixed Asset Turnover = Net Sales (or Operating Revenues)/ Average Net Fixed Assets ● Used to assess a company’s effectiveness at generating sales from its fixed assets ● A high rate = effective management ● An increasing rate over time = more efficient fixed asset use Capitalized Interest ● Interest expenditures included in the cost of a self-constructed asset. ● Record by:... when interest is paid ○ DR Asset ○ CR Cash Repairs, Maintenance, and Improvements ● Expenditures made after an asset has been acquired: 1) Ordinary repairs and maintenance a) Recorded as an expense in the current period b) Maintain productive capacity of the asset c) Recurring in nature, involve relatively small amounts of occurrence, and do not directly increase the productive life, operating efficiency, or capacity d) Ex: changing oil, replacing lights, fixing torn fabric e) DR Maintenance and repairs expense; CR Cash 2) Improvements a) Increase productive life, operating efficiency, or capacity b) Are capital expenditures - an increase in assets and net income c) Involve large amounts of money and increase an asset’s economic usefulness d) Ex: additions, reconditioning, replacements, improvements Depreciation

● The process of allocating the cost of buildings and equipment (but not land) over their productive lives using a systematic and rational method ● Expense recognition (matching) principle: a portion of an asset’s cost be allocated as an expense in the same period that revenues are generated by its use ● Calculating depreciation expense: - an estimate ○ 1) Acquisition cost ○ 2) Estimated useful life of the company: the expected service life of an asset to the present owner ○ 3) Estimated residual value at the end of the asset’s useful life to the company: the estimated amount to be recovered by the company, less disposal costs, at the end of an asset’s estimated useful life Alternative Depreciation Methods 1) Straight-line - most commonly used a) Method that allocates the depreciable cost of an asset in equal periodic amounts over its useful life. b) Formula: Depreciable cost→ (Cost - Residual Value) x (1/ useful life) ← Straight-line rate = depreciation expense c) Depreciation expense is a constant amount each year d) Accumulated Depreciation increases by an equal amount each year e) Net book value decreases by the same amount each year until it equals the estimated residual value 2) Units-of-production a) Method that allocates the depreciable cost of an asset over its useful life based on the relationship of its periodic output to its total estimated output b) Formula: (Cost - Residual Value)/ Estimated Total Production x (Actual Production) c) Depreciation expense is a variable expense because it varies directly with production or use 3) Declining-Balance a) Method that allocates the net book value (cost minus accumulated depreciation) of an asset over its useful life based on a multiple of the straight-line rate, thus assigning more depreciation to early years and less depreciation to later years of an asset’s life b) Formula: (Cost - Accumulated Depreciation) x (2/ Useful Life) Tax Reporting ● Two different measures: GAAP and Internal Revenue Code Measuring Asset Impairment

1) Test for Impairment: when events or changed circumstances cause the estimated future cash flows to these assets to fall below their book value 2) Computation of Impairment Loss: Net Book Value - Fair Value Disposal of Property, Plant, and Equipment ● Involuntarily: result of a casualty; covered by insurance ○ Storm, fire, theft, accident ● Voluntarily: deciding not to hold a long-lived asset for its entire estimated life ○ Sales, trade-ins, retirements ● Journal Entries: ○ The cost of the asset and any accumulated depreciation at the date of disposal must be removed from the accounts Acquisition and Amortization of Intangible Assets ● Intangible assets are usually evident by a legal document: ■ Goodwill - recognized in a business merger or acquisition ■ Trademarks ■ Copyrights ■ Technology ■ Patents ■ Franchises ■ Licenses and operating rights ● Recorded at historical cost only if they have been purchased ● Definite Life: allocated on a straight-line basis each period over its useful life called amortization: systematic and rational allocation of the acquisition cost of an intangible asset over its useful life ● Indefinite Life: not amortized; must be reviewed at least annually for possible impairment Goodwill ● Goodwill (Cost in Excess of Net Assets Acquired): the excess of the purchase price of a business over the fair value of the acquired business’s assets and liabilities ● The most frequently reported intangible asset ● The favorable reputation that a company has with its customers ● Arise from customer confidence, reputation for good service/ quality goods, location, outstanding management team, and financial standing ● Said to be internally generated and is not reported as an asset ● Only way to record and report goodwill as an asset is to purchase another business ● Fair value of all of its net assets: assets - liabilities Trademark

● An exclusive legal right to use a special name, image, or slogan ● Not record unless purchased Copyright ● Exclusive right to publish, use, and sell a literary, musical, or artistic work ● The limit is 70 years beyond the death of an author. For anonymous authors, the limit is 95 years from the first publication date Technology ● Includes costs for computer software and website development ● Internal use: amortized usually over a short life ● Product that is to be sold, leased, or marketed to customers: amortization expense is included as part of the cost of sales Patent ● Granted by the federal government for an invention; gives the owner the exclusive right to use, manufacture, and sell the subject of the patent Franchise ● A contractual right to sell certain products or services, use certain trademarks, or perform activities in a geographical region Licenses and Operating Rights ● Obtained through agreements with governmental units or agencies; permit owners to use public property in performing their services Acquisition and Depletion of Natural Resources ● Natural Resources: assets occurring in nature, such as mineral deposits, timber tracts, oil, and gas ● Called wasting assets because they are depleted (physically used up) ● Produce essential items such as lumber for construction, fuel for heating and transportation, and food for consumption ● Depletion: systematic and rational allocation of the cost of a natural resource over the period of its exploitation ○ Capitalized as part of the cost of the inventory...