Principles of Accounting II Chapter 21: Record and Communicate Operational Investments

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1 Principles of Accounting II Chapter 21: Record and Communicate Operational Investments Multiple Asset Purchases Allocate total purchase price among assets based on relative. Suppose you buy a building site and a parking lot across the street for $ total. Real estate appraisals show the building site and parking lot are worth $ and $, respectively. Total market value: Allocated to building site: Allocated to parking lot: Journal entry: Revenue vs. Capital Expenditures expenditures generally provide benefits for one year. o Debited to account o, immaterial expenditures also are 1

2 expenditures provide benefits for one year. o Debited to account or o Cost spread over asset s useful life (e.g., as expense) Asset s Initial Cost Includes all costs necessary to prepare the asset for Purchased asset o price and tax o and in-transit expenses o and expenses o and fees to acquire o and expenses Constructed asset o,, and costs o Construction period and o and expenses 2

3 Maintenance vs. Capital Repairs The costs to maintain an asset are. They are recorded as debits to expense. Extraordinary repairs and betterments are (i.e., recorded as debits to the related account). o extend an asset s life o change an asset s productivity or performance capability Using Plant Assets As a company from using an asset, it the asset s as an over the asset s useful life. o matches the of using the asset to the accounting periods when the asset the company. o Depreciation does measure the decline in an asset s. 3

4 Carrying (or Book) Value An asset s ( ) cost is left on the books without change during the asset s life. Each period, the asset s depreciation is recorded: The asset s cost less its accumulated depreciation is the or. The difference is NOT. Depreciation Methods Straight line o Spread asset s less value over useful. o is what you expect to get, if anything, for the asset when you are finished using it. Depreciation = Units-of-production o Based on asset s production and current Depreciation = 4

5 Declining balance o Annual depreciation equals a of asset s value. o Since percentage is always >, this is an method. o Depreciation cannot reduce asset s value below its value. Depreciation = Road Construction Example City Wide, Inc. built several roads in its downtown development. The roads are expected to last years after which they will be sold to the city for $. Paving and marking cost $. Architect and legal fees were $. Median landscaping cost $. Determine: (1) Depreciable cost of the roads (2) Annual straight line depreciation (3) Carrying value at the end of year 2 (4) Carrying value at the end of year 10 5

6 Straight Line vs. Accelerated In early years, accelerated depreciation is higher than SL. Why? In later years, SL depreciation is higher than accelerated. Why? Stop accelerated depreciation when carrying value equals salvage value. Why? Which method yields the higher operating income in the first half of the asset s life? Units-of-Production Method Depreciation = If the asset s (or ) during the year is, the depreciation expense is high. If, depreciation expense is low. Cost of Texas oil well Estimated salvage value Estimated lifetime gallons Actual gallons pumped: Year 1 Year 2 Year 3 6

7 Determine: (1) Depreciation for first 3 years (2) Carrying value at end of year 3 Year 1 depreciation: Year 2 depreciation: Year 3 depreciation: Texas oil well (historical cost) Accumulated depreciation Carrying value Partial Year Convention The year an asset is and the year it is are partial years. Tracking and recording depreciation for partial years can be tedious. Many companies adopt a partial year. o Take a year depreciation in years. o If many purchases and disposals, this procedure out. 7

8 Errors and Changes in Estimates If a occurs, financial statements. Depreciation involves lots of estimates: o o o If a depreciation estimate changes, only adjust the depreciation. Yellow truck Green truck Salvage value, each truck Useful life, each truck Lifetime miles, each truck Balance sheet after 2 years (no partial years) Yellow truck Accumulated depreciation Green truck Accumulated depreciation Yellow truck: Green truck: 8

9 At the end of year 2, it became apparent that the trucks would last only more year and have salvage value. Change in estimate Yellow truck, carrying value Remaining life Depreciation, year 3 Green truck, carrying value Remaining life Depreciation, year 3 9

10 Asset Disposals When an asset is sold or discarded: o Record year depreciation, o Remove and related from the records, and o Record the gain or loss on disposal Proceeds > carrying value = Proceeds < carrying value = Abba, Inc. bought gray and green vehicles on Gray vehicle Green vehicle Salvage value, each vehicle Useful life, each vehicle Lifetime miles, each vehicle Abba depreciated both vehicles using DDB. Abba sold the gray and green vehicles on for $ and $, respectively. 10

11 Gray Vehicle Year 1: Year 2: Year 3: Original cost Accumulated depreciation Year 1 Year 2 Year 3 Carrying value Sale proceeds Carrying value Loss of sale Journal entry: 11

12 Green Vehicle Year 1: Year 2: Year 3: Original cost Accumulated depreciation Year 1 Year 2 Year 3 Carrying value Sale proceeds Carrying value Loss of sale Journal entry: 12

13 Intangible Assets Intangible assets have no or presence but bestow a or benefit on their owners. Examples include: o Exclusive legal right to use a product o Legal right to use or reproduce a work o Exclusive right to use mark or name o Right to conduce business under name o Right to rent property for period of time Intangible assets are over their estimated useful lives (not to exceed years) using. 13

14 Goodwill is the reputation a particular business has with its,, and. It results from years of. A business with goodwill does not its good reputation; it just. However, the process of growing goodwill is not a that justifies recording it for accounting purposes. For accounting purposes, goodwill is a technical term for the excess over the of the assets when one company another company. If you see goodwill on a balance sheet, you know that part of the company was from another entity. Jaybird Cab Company the assets of Mockingbird Limo, Inc. for $. The market value of the assets are $. The $ difference is recorded as. Goodwill: Tale of Two Companies Two companies could be very similar except Clean Teeth earned its from inception and Drill Deep out its. How will these two companies balance sheets differ? What about their income statements? 14

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