Chapter 9 Long-Term Assets
Financial Accounting
Rijksuniversiteit Groningen
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MANAGEMENT ISSUES RELATED TO LONG-TERM ASSETS
Characteristics Long-term Assets:
- They have a useful life of more than 1 year/ 1 operating cycle
- They are used in the operation of a business
- They are not intended for resale to customers Long-term assets include:
- Tangible assets: have physical substance, usually depreciated over time (Building)
- Natural resources: assets extracted from natural resources, aged by depletion (Coal)
- Intangible assets: have no physical substance, are accounted for through amortization (Goodwill)
Carrying value is unexpired part of an asset’s cost
- Tangible assets o Purchasing value – accumulated depreciation
- Natural resource o Purchasing value – accumulated depletion
- Intangible assets o Purchasing value – accumulated amortization
Asset impairment occurs when the carrying value exceeds its fair value
- Fair value= the amount for which it could be bought or sold in a current transaction How to test for impairment of long-lived assets:
- Total undiscounted future cash flows > carrying value No impairment
- Total undiscounted future cash flows < carrying value Compute present value of the future cash flows Impairment loss = carrying value – discounted cash flows (discounted cash flow) Acquiring Long-Term Assets
How to decide whether to acquire or not?
- Compare Acquisition costs + disposal price and Net annual savings in cash flows
Financing Long-Term Assets How to finance the purchase
- Free Cash Flow Amount of cash that remains after deducting the funds a company must commit to continue operating at a constant level o A positive Free Cash Flow Company is able to reduce debt or expand operations o A negative Free Cash Flow Company has to sell investments, borrow money, or issue stock Free Cash Flow = Net Cash Flows from Operating Activities – Dividends – Purchases of Plant Assets + Sales of Plant Assets
Applying the Matching Rule Using the matching rule resolves 2 issues:
How much of the total cost of a long-term asset to allocate to expense in the current accounting period
How much to retain on the balance sheet as an asset that will benefit future periods 4 important questions about the acquisition/ use/ disposal of long-term assets:
How is the cost determined?
How should expired portion be allocated to revenues?
How should subsequent expenditures be treated?
How should disposal of the asset be recorded
ACQUISITION COST OF PROPERTY, PLANT, AND EQUIPMENT
- Capital expenditures: Expenditure for purchase/expansion of long-term asset o Additions (enlargement of asset’s physical layout) o Betterments (improvements that do not add to physical layout) o Extraordinary repairs (repairs that enhance asset’s useful life or residual value)
- Revenue expenditures: Expenditure for repairs and maintenance General Approach to Acquisition Costs
Acquisition cost are all expenditures to get an asset ready for use Cost of Asset = Cash + Additional Expenditures
Specific Applications
- Land Debited on Land account = Purchase price + Brokerage fees + Legal fees + Tearing down old building – Salvage + Grading Not subject to depreciation
- Land Improvements Recorded in the Land Improvement account
- Buildings = purchase price + all repairs + other expenditures required to make building usable
- Leasehold improvements Improvements on leased property that become the property of the lessor
- Equipment All expenditures connected with purchasing the equipment and preparing it for use
- Group Purchases Combined purchase of land and other assets
Sometimes the depreciation expense has to be adjusted because the useful life was estimated wrongly
- Special rules for tax purposes Tax methods of depreciation allows rapid write-offs of plant assets
DISPOSAL OF DEPRECIABLE ASSETS
Discarded Plant Assets Total accumulated depreciation never exceeds total depreciable cost Journal entry: Accumulated Depreciation Debit Machinery Credit
Plant Assets Sold for Cash 3 assumptions:
- Cash Received equal to Carrying Value Journal Entry: Cash Debit Accumulated Depreciation Debit Machinery Credit
- Cash Received Less than Carrying Value Journal Entry: Cash Debit Accumulated Depreciation Debit Loss on sale of Asset Debit Machinery Credit
- Cash received more than Carrying Value Journal Entry: Cash Debit Accumulated Depreciation Debit Machinery Credit Gain on Sale of Asset Credit
Exchanges of Plant Assets Trading disposable assets in on the purchase of other plant assets
- If trade-in allowance > carrying value then there is a gain
- If trade-in allowance < carrying value then there is a loss
NATURAL RESOURCES
Natural resources are converted to inventory by extraction methods
Depletion Depletion is the exhaustion of a natural resource and the proportion allocation of the cost to the extraction of units Depletion cost per unit = cost of the natural resource/estimated number of units available
Journal Entry: Depletion Expense Debit Accumulated Depletion Credit
Depreciation of Related Plant Assets Plant Assets related to natural resources are depreciated by the production method over the same period as the natural resource
Development and Exploration Costs in the Oil and Gas Industry 2 Methods:
- Successful effort accounting: The cost of a successful exploration is a cost of the resource. An unsuccessful exploration is directly written-off
- Full-costing method: All costs are recorded as assets and depleted over the estimated life of the resources
INTANGIBLE ASSETS
Intangible asset: long-term, non-physical asset - Recorded at acquisition cost - Useful life : period over which the asset is expected to contribute to the company’s future cash flows o Definite useful life: Subject to legal limit Amortized over the useful life o Indefinite useful life: NOT FOREVER! Journal entry: Amortization expense Debit Intangible Asset Credit
Research and Development costs R&D costs are recorded as revenue expenditures
Computer software Costs Software costs are seen as R&D costs till the technology is feasible
Goodwill Depicts a company’s good reputation
Chapter 9 Long-Term Assets
Vak: Financial Accounting
Universiteit: Rijksuniversiteit Groningen
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