Accounting For Managers

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1 Accounting For Managers Professor ZHOU Ning SCHOOL OF ECONOMICS AND MANAGEMENT BEIHANG UNIVERSITY

2 Chapter 7 Long-Lived Non-monetary Assets and Their Amortization

3 The objectives of chapter 7 Plant and equipment: acquisition Accounting for depreciation Plant and equipment: disposal Natural resources Intangible assets 7-3

4 Types of Long-Lived Assets Tangible asset Asset with physical substance Property, plant, and equipment = fixed asset. Intangible asset Intellectual property. No physical substance Examples are patent rights, copyrights 7-4

5 Amortization View capital asset as bundle of services. Similar to prepaid expenses, cost is expensed as company benefits from services. 7-5

6 Types of Long-Lived Assets 7-6

7 Depreciation Gradual conversion of cost into expense. Depreciation is a cost consumed by an entity during an accounting period. Systematic allocation of original cost of an asset to periods in which asset provides benefit to the entity. 7-7

8 Definitions Deterioration = physical process of wearing out. Obsolescence = loss of usefulness because of change in technology or tastes. Physical life = time until asset wears out. Service life = shorter of either time until asset becomes obsolete or time until asset wears out. Book value = net book value = original cost - accumulated depreciation to date. 7-8

9 Judgments required Service life of asset. Residual value at the end of its service life. Net cost = original cost - residual value. Method of depreciation used to allocate cost over useful life of asset. 7-9

10 Depreciation methods Straight line method: Accelerated methods: Declining balance methods. Sum of the years or years digits methods. Units of production method 7-10

11 Declining Balance Method Depreciation = book value * depreciation rate. Double declining balance method = book value * 2 * straight line rate. 7-11

12 Years digits method Depreciation for first year = (cost - residual value) * n / SYD. Depreciation for second year = (cost - residual value) * (n - 1) / SYD. 7-12

13 Depreciation methods 7-13

14 Units of production method depreciation rate Eg. Net cost of truck=$60,000 expected service life=300,000 miles depreciation rate=$60,000/300,000=20% if truck traveled 50,000miles in a year, the depreciation expense=50,000x20%=$10,

15 Choice of Depreciation method Straight-line, accelerated, and units-ofproduction-has its own conceptual basis. Theoretically, different methods would apply to different types of assets. In practice, the method usually chosen is straight-line. Income tax consideration Accelerated depreciation: receiving as quickly as possible the tax saving 7-15

16 Depreciation Accounting Accumulated depreciation: contra-asset account is maintained for the cumulative amount of depreciation. Eg. On Jan. 1,2006, company A acquire an building for $1,000,000 and estimated service life of 40 years and zero residual value. Management decided to depreciate this building on straight-line basis. =$1,000,000/40 yrs.=$25,000/yr. 7-16

17 Depreciation Accounting How to record this depreciation in the financial accounting records. (1) Dec.31,2006 Building, at cost $1,000,000 Less: accumulated depreciation 25,000 building, net $975,000 (2) Dec.31,2007 Building, at cost $1,000,000 Less: accumulated depreciation 50,000 building, net $950,000 Book value 7-17

18 Depreciation Accounting How to record this depreciation in the financial accounting records. To income statement (3) Annual journal entry for depreciation Depreciation expense $25,000 Accumulated depreciation $25,000 (4) Fully depreciation, Dec. 31, 2046 Building, at cost $1,000,000 Less: accumulated depreciation 1,000,000 building, net $0 7-18

19 Plant and Equipment: Disposal Sale of building: Remove cost and accumulated depreciation. Reminder: book value = cost - accumulated depreciation. Gain or (loss) = Selling price of asset - book value. Gain or loss in current period income statement. Cost = market value at time of purchase. 7-19

20 Plant and Equipment: Disposal Example Suppose that at the end of 10 years company A sells its building for $750,000 (book value, back to the case of slice 20) Dr. Dec.31,2016 Building, at cost $1,000,000 Less: accumulated depreciation 250,000 building, net $750,000 Dr. Cash $750,000 Accumulated Depreciation 250,000 Cr. Building $1,000,

21 Plant and Equipment: Disposal Example Suppose that at the end of 10 years company A sells its building for $650,000 less than $750,000(book value), or $850 more than its book value Dr. Cash $650,000 Accumulated Depreciation 250,000 Loss on sale of building 100,000 Cr. Building $1,000,000 Dr. Cash $850,000 Accumulated Depreciation 250,000 Cr. Gain on sale of building $100,000 Building 1,000,

22 Impaired Assets Impaired if remaining benefits, as measured by sum of future cash flows generated by use of asset, is less than its book value. If entity expects to hold asset: Write asset down to fair value If entity expects to sell asset: Write asset down to lower of cost or fair value less cost of disposal. 7-22

23 Natural Resources Measure cost same as other assets. Oil exploration costs: Full cost method: All costs of exploration allocated to and capitalized as the value of reserves discovered during the year. Successful efforts method: Only capitalize costs involved with successful efforts (oil reserves that are discovered). Both allowed under GAAP. 7-23

24 Natural Resources Example A petroleum company explores 10 locations, incurring costs of $10 million at each. It discovers oil and gas reserves at 3 of these location. Full cost method: Dr. Oil and gas reserves, at cost $100,000,000 Cr. cash $100,000,000 Successful efforts method: Dr. Oil and gas reserves, at cost $30,000,000 explore expense $70,000,000 Cr. cash $100,000,

25 Depletion Depletion: the process of amortizing the costs of natural resources in the accounting periods benefited. Units of production method ordinarily used. If an property cost $250 million and is estimated to contain 50 million barrels of oil, the depletion rate is $5 per barrel; the total depletion for a year in which 8 million barrels were produced would be $40 million. 7-25

26 Internally Developed or Acquired Internally developed are expensed as incurred. Acquired are capitalized. 7-26

27 Categories of Intangibles Intangible assets with limited lives. Intangible assets with indefinite lives. Goodwill. 7-27

28 Intangible Assets Limited Useful Life Examples: patents and copyrights. If purchased, recorded at cost. Amortized over useful life. Useful life can equal or be shorter than legal life. Amortization should reflect the pattern in which the economic benefits are consumed. Straight line if pattern cannot be determined. If developed internally, expense as incurred. 7-28

29 Intangibles with Indefinite Useful Lives Example: renewable broadcast license. Considered indefinite if no legal, regulatory, contractual, competitive or other limiting factors. Not amortized. Tested for impairment. If determined to be impaired, it is written down to realizable value and charged against income. 7-29

30 Goodwill When one company buys another. Goodwill = Purchase price of company fair value of net assets. Net assets include tangible assets and recognized intangible assets net of liabilities assumed by the purchaser. Recorded as an asset upon acquisition. Not amortized. Annual impairment test. Any write down is charged against income. 7-30

31 Goodwill Example Company A acquire all the assets of Company B, giving Company B $1,500,000 cash. Company B has cash of $50,000, accounts receivable that are believed to have a realizable value of $60,000,and other acquired assets other than goodwill that are estimated to have a fair value of $1,100,000. The amount of goodwill is calculated as follows: Dr. Total purchase price $1,500,000 less cash $50,000 accounts receivable 60,000 other acquired assets 1,100,000 1,210,000 Goodwill $ 290,

32 Intangible Assets with Limited Lives Examples: patents and copyrights. If purchased, recorded at cost. Amortized over useful life. Useful life can equal or be shorter than legal life If developed internally, expense as incurred. 7-32

33 Start-up Costs Start-up Costs in pre-operating period. Expense or Capitalize and amortize over a short period (rarely more than 5 years). 7-33

34 Research & Development (R&D) Costs Costs incurred to: Develop new knowledge, products or improve goods, processes, or services. GAAP: Expense since future benefits uncertain. Argument for capitalizing: Matching concept. Argument for immediate expensing: Conservatism, objectivity. 7-34

35 Analysis of Nonmonetary Assets To estimate: 7-35

36 Summary of Chapter 7 Plant and equipment: acquisition Accounting for depreciation Plant and equipment: disposal Natural resources Intangible assets 7-36

37 Assignments of Chapter 7 Problem 7-1 Problem

38 Thank you 7-38

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