Acquisition cost Purchase price plus all expenditures needed to prepare the asset for its intended use
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1 CAPITAL ASSETS Issues to consider: Compute initial acquisition cost Account for subsequent costs Allocate cost to periods benefited Record disposal Acquisition cost Purchase price plus all expenditures needed to prepare the asset for its intended use AMORTIZATION Amortization is a cost allocation process that systematically and rationally matches acquisition costs of capital assets with periods benefited by their use. Amortization Expense is the amortization for the current year Accumulated Amortization is the total amortization to date on balance sheet Factors in Computing Amortization Cost the initial cost of purchasing the asset Salvage value (residual value or scrap value) an estimate of the asset's value at the end of its benefit period. Useful life (service life) length of time the asset is expected to be productively used in a company's operations. STRAIGHT LINE METHOD Charges the same amount to expense for each period of the asset s useful life. Method used by most companies. Amortization Expense = Cost of asset Estimated value at end of estimated useful life Estimated Useful Life : ACME purchases a machine to make shoes on January 2 nd, The machine cost $10,000. The company estimates that it will last 5 years and have a salvage value of $1000. What is the amortization expense for 2005? Page 1 of 10
2 Complete the amortization schedule Year Amortization Expense Accumulated Amortization Total UNITS-OF-PRODUCTION METHOD Charges a varying amount to expense for each period of an asset s useful life depending on its usage. Charges are based on the consumed capacity of the asset. s of capacity measurements: km driven, product outputs, hours used. Computation: Cost minus salvage value divided by the number of accounting periods in the asset's useful life equals the amortization per unit. Amortization per unit times the number of units consumed in period equals the period s amortization. ACME purchases a machine to make shoes. The machine cost $10,000. The company estimates that it will produce 36,000 units and have a salvage value of $1000. What is the amortization expense for 2009 if the company produces 7000 shoes? Calculations Page 2 of 10
3 Complete the Amortization Schedule for the life of the machine. Year Amortization Expense Accumulated Amortization 2005 (7,000 units) 2006 (10,000 units) 2007 (8,000 units) 2008 (7,000 units) 2009 (4,000 units) Total (36,000 units) Amortization is based on assumptions. Sometimes those estimates are wrong. Be careful that the total units of production don t exceed the estimate. Simple : You purchase a machine to make widgets for $1000. You assume you will produce 15,000 widgets and the machine will have no salvage value at the end. Year Estimated Actual Estimated Amortization Expense Actual Amortization Expense Total Page 3 of 10
4 DOUBLE DECLINING-BALANCE METHOD An accelerated amortization method. Charges larger amortization during the early years of an asset's life and smaller expenses in the later years. Watch the accumulated amortization carefully. You don t want to exceed the total value. ACME purchases a machine to make shoes on January 2nd, The machine cost $10,000. The company estimates that it will last 5 years and have a salvage value of $1000. What is the amortization expense for 2009? Calculations Page 4 of 10
5 Complete the amortization schedule Year Amortization Expense Accumulated Amortization Total Comparison of the Three Methods Year Straight Line Units of Production Double Declining Total OTHER AMORTIZATION CONSIDERATIONS Amortization and Income Tax Many companies use accelerated amortization in computing taxable income because it postpones tax payments by charging higher amortization expense in the early years and lower amounts in the later years. Income Tax Act requires that companies use a declining-balance method for calculating the maximum capital cost allowance that may be claimed in any period. The Income Tax Act specifies the prescribed rates for various groups of assets Partial Year Amortization When an asset is purchased at a time other than the beginning or end of an accounting period, amortization is recorded for the part of the year the asset was in use. Two methods: Nearest whole month Half year rule amortization for the first year of an asset s life is always half a year regardless of when the asset was purchased Page 5 of 10
6 : ACME purchased the $10000 shoe machine on March 21st instead of January 2nd. What is the amortization expense if they use a straight-line, nearest whole month method? Accounting Unit 4b What is the amortization expense if they use a straight-line, half-year rule method? Revising Amortization Rates Over the life of an asset, new information may come to light that indicates the original estimates were inaccurate. When our estimates change, amortization is: There are two general reasons that you would revise an amortization rate: o You change the underlying assumptions o You change the machine. 1 ACME uses the straight line, nearest whole month method of amortization. ACME purchases a machine to make shoes on March 21st, The machine cost $10,000. The company estimates that it will last 5 years and have a salvage value of $1000. In 2007 the company decides the machine will last 1 more year and have a salvage value of $500. What is the amortization expense in 2007? Page 6 of 10
7 2 ACME uses the straight line, nearest whole month method of amortization. ACME purchases a machine to make shoes on March 21st, The machine cost $10,000. The company estimates that it will last 5 years and have a salvage value of $1000. On June 1st, 2007 the company upgraded the machine. The upgrades cost $5000. They increased the life of the machine by 2 years and increased the salvage value by $2000. What is the amortization expense for 2007? DISPOSALS OF CAPITAL ASSETS Assets may be discarded, sold, or exchanged due to wear and tear, obsolescence, inadequacy, or damage by fire or other accident. In general, accounting for disposals requires we: o Record amortization expense up to the date of disposal. This updates the accumulated amortization account. o Remove the balances of the disposed asset and related accumulated amortization accounts. o Record any cash (and other assets) received or paid in the disposal. o Record any gain or loss resulting from comparing the asset's book value with the value received in the disposal. Discarding Capital Assets If fully amortized no loss (can never have gain if discarding) If not fully amortized Record a loss (debit) equal to the book value. A machine costing $9,000 with accumulated amortization of $9,000 is discarded on June 5, Page 7 of 10
8 A machine costing $8,000 with accumulated amortization of $6,000 on December 31, 2008 is discarded on July 1, 2009.The equipment is being amortized over 8 years with no salvage value. Selling Capital Assets Compare value received to book value to determine gain (receive value greater than book value) or loss (receive value less than book value). Sale is at a gain if value received exceeds book value. Sale at a loss if value received is less than book value. Record cash received (debit) Remove accumulated amortization (debit). Record a gain (credit) or loss (debit). Remove the asset cost (credit). Delivery equipment costing $16,000 with accumulated amortization of $12,000 (on December 31, 2009) is sold on April 1, 2010 for $3000. Annual amortization is $4,000 (straight-line). Page 8 of 10
9 Same example except sold for $7000. Same example except sold for $2500 INTANGIBLE ASSETS Non-current assets without physical substance. Often provide exclusive rights or privileges. Useful life is often difficult to determine. Usually acquired for operationaluse. s Patents Copyrights Leaseholds Leasehold Improvements Goodwill Trademarks and Trade Names Page 9 of 10
10 Amortization Amortize over shorter of economic life or legal life, subject to a maximum of 40 years. Intangible assets, traditionally, do not have contra accounts. The amortization account is an expense. Use the straight line method unless the company can show another method is preferred. Research and development costs are normally expensed as incurred. ACME company purchases the patent to a new anvil for $42,000 on January 2nd, The patent has a legal life of 20 years and is expected to be used for 15 years. What is the adjusting entry for December 31st, 2009? Goodwill No longer amortized under revised Canadian GAAP Occurs when one company buys another company. Only purchased goodwill is an intangible asset. The amount by which the purchase price exceeds the fair market value of net assets acquired. ACME purchases Widget Industries for $3,000,000 on June 2nd, What is the goodwill generated for ACME? Widget Industries Condensed Balance Sheet Page 10 of 10
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