STUDY OBJECTIVE 1 CAPITAL ASSETS

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1 Collaboratively Created Collection of Chapter 10 Content STUDY OBJECTIVE 1 CAPITAL ASSETS Capital Assets are used throughout many cycles of a business and are reused over and over again. These assets are not sold. There are two different types of Capital Assets: tangible and intangible. Distinguish between tangible and intangible capital assets. Tangible assets include fixed assets which includes things such as machinery, buildings and land, as well tangible assets include currents assets such as inventory and cash on hand. o Tangible assets can be divided into two separate categories named Property, Plant, and Equipment and Natural Resources. Natural Resources deplete as they are used, whereas Property, Plant and Equipment do not deplete. o When we use equipment, it physically stays the same as we use it. When we use Natural Resources such as timber, a part of its physical substance is used up each time. Intangible assets are things that are not physical to the company. These types of assets are benefits, special rights and privileges. o Intangible assets include things such as patents, trademarks, copyrights, goodwill and brand recognition. 2. DEMONSTRATE THE APPLICATION OF THE COST PRINCIPLE TO PROPERTY, PLANT, AND EQUIPMENT SPECIFICALLY, AND TO CAPITAL ASSETS IN GENERAL Property, plant and equipment (and more capital assets) are recorded at historical cost in accordance with the cost principal of accounting. Cost is all expenditures needed to buy and make it ready for its intended use. The costs are capitalized (recorded as capital assets). Cash is measured by cash paid (fair market value) or cash equivalent fair market price when cash is not used. If an assets fair market value falls below its net book value, an impairment loss is recorded (reduce the asset s net book value to its fair market value, it does not adjust back for any recovery). Land Land = Initial price of property + Costs for clearing the land + Legal Fees/Survey Fees Cash Price of property 100,000 Net removal cost of warehouse 6,000 Legal fee 3,000 Total cost of land 109,000

2 Land Improvements Land itself is not amortized b/c it has an unlimited useful life Costs of paving, fencing, signs lighting, landscaping are items to improve the land and have a limited life and are amortized over their useful life times. Building All costs of the building including purchasing the building and all necessary construction costs are debited from the buildings account. Included in the purchase price are all legal fees like the closing costs. Construction costs include the contract price of the building all remodeling including wiring, plumbing, excavation, fees for architects, and interest payments Equipment The real cost of equipment is cash price plus other related costs, such as: freight, insurance (during transit), installation, testing, painting, etc. These do not include motor vehicle licenses and and insurance on company trucks and cars.these other prices are called related expenditures, and are recorded below the actual price of the asset. Basket Purchase This occurs when a group of capital assets is purchased altogether for a single price. We can find their worth by finding each assets relative fair market values and adding them together after ammortization. 3. EXPLAIN THE CONCEPT OF, AND BE ABLE TO CALCULATE, AMORTIZATION. Amortization the allocation of the cost of a capital asset (such as property, plant, and equipment) to expense over its useful (service) life in a rational and systematic manner. How to journalize Debit: Amortization expense ; Credit: Accumulated Amortization About Amortization: Accumulated amortization appears on the balance sheet as a contra asset Cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle. During an asset s life, its usefulness may decline because of wear and tear or obsolescence. Recognition of amortization does not result in the accumulation of cash for the replacement of the asset. Land is the only capital asset that is not amortized.

3 Factors in Calculating Amortization 1. Cost all expenditures necessary to acquire the asset and make it ready for intended use 2. Useful Life and estimate of the expected productive life, also called service life, of the asset. Useful life may be expressed in terms of time, units of activity, or units of output. 3. Residual Value an estimate of the assets value at the end of its useful life. This value is based on the assets worth as scrap or on its expected trade-in value. 4. CALCULATE PERIODIC AMORTIZATION USING DIFFERENT METHODS. Straight-line Method - Under the straight-line method, amortization is the same for each year of asset s useful life, it is measured over time - To determine the amortizable cost it is the asset less its residual value Cost - Residual Value = Amortizable Cost - The amortizable cost is divided by the asset's useful life to determine the annual amortization expense Amortizable Cost / Useful Life (in years) = Annual Amortization Expense - Alternatively, we can calculate an annual rate of amortization Amortization Expense / Amortizable Cost = Straight-Line Rate of Amortization (%) - Many large companies use this method like; Coca-Cola, Bell and Bombardier because it is simple to apply and it matches expenses with revenues when the asset is used throughout its service life Declining Balance based on the declining net book value Asset Cost - Accumulated Amortization = Net Book Value amortization expense is calculated using the straight-line amortization rate Net Book Value Beginning of Year x Amort. Rate (%) = Amort. Expense At the beginning of the first year, accumulated amortization is zero This method does not use amortizable cost. Residual value is ignored. However residual value limits total amortization that can be taken straight-line rate always results in a final value greater than residual Different rates of amortization can be used depending on the company These include 1x, 1.5x, 2x and even 3x the straight-line rate 2x is often used double declining balance method Amortization can be calculated for less than a year Net Book Value x Amort. Rate (%) x Time (years) = Partial Amort. Exp. This method respects matching principle Not as popular as other methods, but is still used by companies like Canadian Tire and Cara Operations

4 Units-of-Activity -Under this method, useful life is expressed as the total units of activity or production expected from the asset, rather than as a time period. -This method is usually used for factory machinery (production is measured in units of output or machine hours) and assets like delivery equipment (kilometres driven) Equation: Estimated Total Activity / Amortizable Cost = Amortization cost per unit or Units of Activity x Amortizable Cost per Unit = Amortization Expense -This method is not nearly as popular as the others because it is often difficult to estimate total activity -When the productivity of an asset varies significantly from one period to the next, the unitsof-activity method results in the best matching of expenses and revenues 5. DESCRIBE AND DEMONSTRATE THE PROCEDURE FOR REVISING PERIODIC AMORTIZATION If the amortization of an expense is inadequate or excessive, a correction should be made to the periodic amount When a change is made: o You do not correct the previous recorded amount for the expense o The amortization expense for current and future years is revised To determine the new annual amortization expense, you must first calculate the asset s net book value at the time of the change in estimate Next deduct any revised residual value to determine the amortizable cost at the time of revision Then, the revised amortizable cost is then divided by the remaining useful life o The formula for revised amortization expense: Revised amortization expense = (Net Book Value revised salvage value) remaining useful life Example: Net Book Value, Jan 1, 2014 $11,200 Less: Revised residual value $700 Revised amortizable cost $10,500 Remaining useful life ( ) 3 years Revised Residual amortization $3,500

5 9. CONTRAST THE ACCOUNTING FOR INTANGIBLE ASSETS WITH THE ACCOUNTING FOR TANGIBLE ASSETS. Both tangible and intangible assets benefit future periods and are used to produce products/services over periods. Tangible assets have physical existence, intangible assets are rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance. Accounting for intangible assets parallels accounting for tangible assets: Intangible assets are: (1) Recorded at cost, (2) amortized over the useful life of the asset in a rational and systematic manner Amortizable intangible assets: Have defined lives Straight line method used Allocation of the cost to expense over the shorter of (1) useful (economic) life, (2) legal life Unamortizable intangible assets: Indefinite useful lives Do not amortize Test for impairment Types of intangible assets: Patents Copyrights Trademarks and Trade Names Franchises and Licenses Goodwill Research and Development Costs 1) Patents Exclusive right to manufacture, sell or control granted for 20 years Legal costs of protecting a patent in an infringement suit are added to the Patent account and amortized over the remaining life of the patent The initial cost of a patent is the cash or cash equivalent price paid to acquire it The cost of patent should be amortized over its 20 year legal life, or its useful life, whichever is shorter 2) Copyrights Copyrights are granted by the Canadian Intellectual Property Office. They give an owner exclusive rights to reproduce and sell their work Copyrights extend for the life of the creator plus 50 years Cost of copyright consists of the cost of requiring and defending it Cost can increase with copyright infringement

6 3) Trademarks and Trade Names Word, phrase, jingle or symbol that distinguishes or identifies a particular enterprise or product (Ex: Nike, KFC, Coke) Trade names create immediate product identification, also enhance sales Creator maintains exclusive legal right by registering it with the Canadian Intellectual Property Office. This may be renewed every 15 years. If indefinite life, do not amortize. Test for impairment If purchased, its cost is the purchase price If developed, costs include legal fees, registration fees, design costs, etc. 4. Franchise -a franchise is a contract agreement between a franchisor and franchisee. -gives the permission to the franchisee to sell certain products, offer specific services, or use certain trademarks or trade names Licenses - Another type is a contract between a government body and a company -franchise permits the company to use private property to perform service Ex. City streets for taxi or bus service -when cost can be identified with the acquisition of the franchise or license and intangible asset should be recognized -annual payments, proportionate with sales, are sometimes required in a franchise agreement. This is a royalty and recorded as a operating expense Goodwill Goodwill is typically the largest intangible asset on a company s balance sheet Goodwill represents favorable attributes that relate to a business enterprise A solid customer base, skilled employees and quality products are some attributes of goodwill Goodwill is recorded only in an exchange transaction that involves the purchase of an entire business Goodwill equals the excess of cost over the fair market value of the net assets (assets less liabilities) acquired Goodwill is not written off because it has an indefinite life. It must be tested regularly for impairment Research and Development Costs Research and development costs are not intangible assets Research costs record as an expense when incurred Development costs capitalize if associated with an identifiable, feasible product. Otherwise, expense Research and development costa present two accounting problems: Sometimes difficult to determine the costs for specific projects Hard to know the extent and timing of future benefits Research is planned investigation undertaken to gain new knowledge and understanding All research costs should be expensed when incurred Development is the use of research findings and knowledge for a plan or design Certain development costs with reasonably assured future benefits can be capitalized