FINANCIAL ACCOUNTING A USER PERSPECTIVE

1. FINANCIAL ACCOUNTINGA USER PERSPECTIVE Hoskin • Fizzell • Davidson Second Canadian Edition

2. Capital Assets Chapter Eight

3. Capital Asset Recognition • Capital assets • Used to generate revenue over several periods in the future • Used until replaced with a new asset • Can have residual (or resale) value

4. Capital Asset Valuation • Historical cost • Original cost of the asset • Expensed (amortized) over the period used

5. Capital Asset Valuation • Gain or loss on sale • Recognized only when sold • Difference between proceeds of the sale and the net book value • Net book value (or carrying value) • Original cost less amortization

6. Capital Asset Valuation • Market value • Replacement cost • Amount that would be needed to acquire an equivalent asset • Net realizable value • Amount that could be received by converting the asset to cash

7. Capital Asset Valuation • Canadian practice • Uses historical cost • Amortized over the period of use • Maximum of 40 years • Market value changes generally not recognized

8. Capitalizable Costs • Costs to acquire and prepare the asset for use • Purchase price (less any discounts) • Installation costs • Transportation costs • Legal costs • Direct taxes

9. Basket Purchases • Several assets acquires in one transaction • Price paid is divided between the assets on the basis of their relative fair values at the time of acquisition

10. Basket Purchases Timberland Example

11. Interest Capitalization • Companies often borrow money to finance a capital asset • Interest paid on borrowed money • Capitalized when it is included in the capital asset account rather than being expensed

12. Amortization (or Depreciation) • Method for allocating the cost of capital assets to the periods in which the benefits from the assets are received (the useful life) • Does not refer to the value of the asset • Follows the matching concept

13. Amortization Methods • Straight-line method • Accelerated or diminishing balance method • Decelerated method • Unit of production method

14. Amortization Methods Asset Carrying Value Dol lars

15. Amortization Methods Amortization Expense Do l lars

16. Straight-Line Method • Allocates the cost evenly over the life of the asset • Estimates needed for • Useful life • Residual value

17. Straight-Line Method • Assumptions: • Original Cost $10,000 • Estimated • Residual Value $1,000 • Useful Life 5 years

18. Straight-Line Method - Original Cost Residual Value Amortization Expense = Useful Life - $10,000 $1,000 = 5 years = $1,800 per year

19. Straight-Line Method Amortization Schedule

20. Accelerated Methods • Amortization • Multiply the carrying value of the asset by a fixed percentage • Carrying value decreases each year • Amortization expenses decreases each year

21. Accelerated Methods • Percentage rates • Lower when asset has longer life • Double declining balance method • Percentage is double the straight-line rate • Residual value • Not used for computations • Serves as a constraint

22. Double Declining Balance Method • Assumptions: • Original Cost $10,000 • Estimated • Residual Value $1,000 • Useful Life 5 years • 200% Declining Balance Method

23. Double Declining Balance Method • Calculation: DB rate = DB% x SL rate = 200% x 1/n = 200% x 1/5 = 40%

24. Double Declining Balance Method Amortization Schedule

25. Production Method • Assumptions • Benefits derived are related to the output or use of an asset • Requires that the useful life can be expressed as units of output

26. Production Method • Assumptions: • Original Cost $10,000 • Estimated Residual Value $1,000 • Estimated Usage

27. Production Method - Cost Residual Value Amortization Expense per Unit = Estimated Total Units of Output - $10,000 $1,000 = 20,000 units = $0.45 per unit

28. Production Methods Amortization Schedule

29. Recording Amortization Expense • All amortization methods: SE-Amortization expense XX XA-Accumulated amortization XX

30. Corporate Income Taxes • Revenue Canada • Amortization expense is allowed to be deducted to calculate accounting income • Capital cost allowance (CCA) instead must be used to calculate taxable income

31. Corporate Income Taxes • May result in a temporary difference betweenAccounting income and taxable income • Result is a future tax asset or liability (formerly referred to as deferred tax)

32. Capital Cost Allowance (CCA) • Capital assets are grouped into classes and assigned a maximum rate • Vehicles: Class 10: rate 30% • Equipment: Class 8: rate 20%

33. Capital Cost Allowance (CCA) • Companies may deduct any part of the undepreciated capital costs (UCC) in the class up to the stated maximum • Exception: • Year of acquisition: 50% of normal amount

34. Capital Cost Allowance (CCA) • Central Corp. purchases new equipment (Class 8) at a cost of $20,000 • CCA Year 1: 50% x $20,000 x 20% = $2,000 Year 2: 20% x ($20,000-$2,000)= $3,600 Year 3: 20% x ($20,000-$2,000-$3,600) = $2,880

35. Capital Cost Allowance (CCA) • Journal entry: SE-Tax expense 11,460 A-Future tax asset* 90 L-Income taxes payable 11,550 *(Future tax liability if a credit balance)

36. Changes in Amortization Estimates and Methods • Estimates of useful life and residual value may change over time • Amortization may change as a result

37. Changes in Amortization Estimates and Methods • Straight-Line Method Assumptions • Original Cost $10,000 • Residual Value $1,000 • Useful Life 5 years • Changes in Year 4 (Estimations) • Remaining Useful Life 3 years • Residual Value $ 400

38. Changes in Amortization Estimates and Methods Remaining Book Value - Residual Value Amortization Expense = Useful Life - $4,600 $400 = 3 years = $1,400 per year

39. Changes in Amortization Estimates and Methods Amortization Schedule

40. Sale of Capital Assets • Original cost and accumulated amortization removed from accounts • Gain or loss: difference between cash received and book value A-Cash 1,200 XA-Accumulated amortization 9,000 A-Property, plant and equipment 10,000 SE-Gain on sale of PP&E 200

41. Disposal of Capital Assets • If assets are disposed of and no cash is received XA-Accumulated amortization 9,000 SE-Loss on disposal of PP&E 1,000 A-Property, plant and equipment 10,000

42. Writedown of Capital Assets • If future recoverable amount of a capital asset declines below its carrying value SE-Loss due to damage to asset 1,000 XA-Accumulated amortization 1,000

43. Natural Resources • Capitalizing the costs implies that they have future value • Example: oil exploration • Exploration costs choices • Full costing method • Successful efforts method

44. Intangible Assets • Intangible assets have probable future value but no physical form • Guidelines: • If developed internally, expense as incurred • If purchased, can be capitalized

45. Intangible Assets • Estimate useful life and residual value (if any) • Use straight-line method to amortize SE-Amortization expense XX A-Patents XX

46. Intangible Assets • Advertising • Generally expensed as incurred • Patents, Trademarks, Copyrights • Legal life is the maximum for amortizing • Goodwill • Capitalize and amortize if purchased

47. Return on Assets Net income before interest ROA = Average total assets Net income + [Interest expense x (1-Tax rate)] = Average total assets