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Chapter 10 Amortization

Chapter 10 Amortization. Illustration 10-6. FACTORS IN CALCULATING AMORTIZATION. AMORTIZATION METHODS.

rashad-henderson
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Chapter 10 Amortization

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  1. Chapter 10Amortization

  2. Illustration 10-6 FACTORS IN CALCULATING AMORTIZATION

  3. AMORTIZATION METHODS Three methods of recognizing amortization are:1. Straight-line,2. Units of activity, and 3. Declining-balance. Each method is acceptable under generally accepted accounting principles. Management selects the method that is appropriate for their company. Once a method is chosen, it should be applied consistently.

  4. STRAIGHT-LINE METHOD

  5. STRAIGHT-LINE METHOD • Amortization is constant for each year of the asset's useful life

  6. Net Book Value (at beginning of year) Straight-line Rate (x declining balance rate multiplier, if any) Amortization Expense DECLINING-BALANCE METHOD • The calculation of periodic amortization is based on a declining net book value (cost less accumulated amortization) of the asset. • The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year.

  7. DECLINING-BALANCE METHOD • Accelerated methods result in more amortization in early years and less in later years

  8. Total Units of Activity Amortized Cost Amortizable Cost per Unit Units of Activity during the Year Amortizable Cost per Unit Amortization Expense UNITS-OF-ACTIVITY METHOD To use the units-of-activity method, 1) the total units of activity for the entire useful life are estimated, 2) the amount is divided into amortizable cost to calculate the amortization cost per unit, and 3) the amortization cost per unit is then applied to the units of activity during the year to calculate the annual amortization.

  9. UNITS-OF-ACTIVITY METHOD • Useful life is expressed in terms of total units of production or activity expected from the asset

  10. REVISING PERIODIC AMORTIZATION • If annual amortization is inadequate or excessive, a change in the periodic amount should be made. • When a change is made, 1. there is no correction of previously recorded amortization expense and 2. amortization expense for current and future years is revised. Revised amortization expense = Net book value at time of revision – revised salvage value Remaining useful life

  11. EXPENDITURES DURING USEFUL LIFE • Ordinary repairsare expenditures to maintain the operating efficiency and expected productive life of the capital asset. • They are debited to Repairs Expenseas incurred and are often referred to as operating expenditures. • Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the capital asset. 1. Expenditures are usually material in amount and occur infrequently during the period of ownership. 2. Since additions and improvements increase the company’s investment in productive facilities, they are debits to the capital asset affected, and are referred to as capital expenditures.

  12. CAPITAL ASSET DISPOSALS Capital assets may be disposed of by a) retirement b) sale, or c) exchange

  13. CAPITAL ASSET DISPOSALS 1 Amortization for the fraction of the year to the date of disposal must be recorded Amortization expense xxx Accumulated amortization xxx Calculate net book value Net book value = Cost - accumulated amortization 2

  14. CAPITAL ASSET DISPOSALS Compare net book value to sale proceeds Proceeds > Net book value = gain (cr.) Proceeds < Net book value = loss (dr.) Record disposition, removing cost of asset and accumulated amortization, and record proceeds (if any) and gain or loss on disposition (if any) 3 4 Cash xxx Accumulated amortization xxx Capital asset xxx Gain on disposal xxx

  15. NATURAL RESOURCES • Natural resourcesconsist of standing timber and underground deposits of oil, gas, and minerals. • Natural resources, frequently calledwasting assets, have two distinguishing characteristics: 1. They are physically extracted in operations. 2. They are replaceable only by an act of nature.

  16. ACQUISITION COST • Theacquisition costof a natural resource is the cash or cash equivalent price necessary to acquire the resource and prepare it for its intended use. • If the resource is already discovered, cost is the price paid for the property.

  17. AMORTIZATION • Theunits-of-activity methodis generally used to calculate amortization, because periodic amortization generally is a function of the units extracted during the year.

  18. Total Estimated Units Amortizable Cost = (Cost – Residual Value + Restoration Costs) Amortization Cost per Unit Number of Units Extracted and Sold Amortization Cost per Unit Amortization Expense ILLUSTRATION 10-23FORMULA TO CALCULATE AMORTIZATION EXPENSE

  19. ILLUSTRATION 10-24STATEMENT PRESENTATION OF AMORTIZATION Accumulated Amortization, a contra asset account, is deducted from the cost of the natural resource in the balance sheet as follows:

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