accounting principles second canadian edition prepared by: carole bowman, sheridan college weygandt...
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Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Weygandt Kieso Kimmel Trenholm Slide 2 CAPITAL ASSETS CHAPTER 10 Slide 3 Capital assets are long-lived assets that are used in the operations of a business and are not intended for sale to customers. Capital assets are subdivided into two classes: 1. Tangible (with physical substance) 2. Intangible (without physical substance) CAPITAL ASSETS Slide 4 TANGIBLE ASSETS Tangible assets include: property, plant and equipment natural resources such as mineral deposits, oil and gas reserves, and timber Slide 5 PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment can be classified as: 1. Land 2. Land improvements 3. Buildings 4. Equipment Slide 6 INTANGIBLE ASSETS Intangible assets provide future benefits through the special rights and privileges they convey. Examples: Patents, copyrights, sports contracts, and trademarks Slide 7 Capital assets are recorded at cost in accordance with the cost principle. Cost consists of all expenditures necessary to 1) acquire the asset and 2) make it ready for its intended use. These costs include purchase price, freight costs, and installation costs. Expenditures that are not necessary should be recorded as expenses, losses, or other assets. Invoice DETERMINING THE COST OF CAPITAL ASSETS Slide 8 Cost is measured by the cash paid in a cash transaction or by the cash equivalent price when non-cash assets are used in payment. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable. MEASUREMENT OF CAPITAL ASSET COST Slide 9 The cost of Land includes: 1. cash purchase price 2. closing costs such as title and legal fees 3. real estate brokers commissions 4. accrued property taxes and other liens on the land assumed by the purchaser All necessary costs incurred in making land ready for its intended use are debited to the Land account. LANDLAND Slide 10 ILLUSTRATION 10-2 COMPUTATION OF COST OF LAND Sometimes purchased land has a building on it that must be removed to make the site suitable for construction of a new building. In this case, all demolition and removal costs less any proceeds from salvaged materials are chargeable to the Land account. Slide 11 The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use, such as: 1. parking lots 2. fencing 3. landscaping 4. lighting Lighting Parking Lot LAND IMPROVEMENTS Slide 12 The cost of buildings includes all necessary expenditures relating to the purchase or construction of a building. When a building is purchased, such costs include the purchase price, closing costs, and real estate brokers commission. Costs to make the building ready for its intended use consist of expenditures for remodelling and replacing or repairing the roof, floors, wiring, and plumbing. When a new building is constructed, cost consists of the contract price plus payments for architects fees, building permits, interest payments during construction, and excavation costs. BUILDINGSBUILDINGS Slide 13 The cost of equipment consists of the cash purchase price, provincial sales taxes, freight charges, and insurance paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing, and testing the unit. Recurring costs such as licenses and annual insurance are expensed as incurred. EQUIPMENTEQUIPMENT Slide 14 ILLUSTRATION 10-3 COMPUTATION OF COST OF DELIVERY TRUCK The cost of equipment consists of the cash purchase price, provincial sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit. However, recurring costs such as motor vehicle licenses and accident insurance on company cars and trucks are expensed as incurred. Delivery Truck Cash Price$22,000 Painting and lettering 500 Cost of delivery truck$22,500 Slide 15 ENTRY TO RECORD PURCHASE OF TRUCK The entry to record the cost of the delivery truck and related expenditures is as follows: Delivery Truck Cash Price$22,000 Painting and lettering 500 Cost of delivery truck$22,500 Slide 16 ENTRY TO RECORD PURCHASE OF MACHINERY The summary entry to record the cost of the factory machinery and related expenditures is as follows: Factory Machinery Cash price $50,000 Insurance during shipping 500 Installation and testing 1,000 Cost of factory machinery$51,500 Slide 17 Amortization is the process of allocating to expense the cost of a capital asset over its useful (service) life in a rational and systematic manner. Cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle. During an assets 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. AMORTIZATIONAMORTIZATION Slide 18 Three factors that affect the computation of amortization are: FACTORS IN COMPUTING AMORTIZATION 1. Cost: all expenditures necessary to acquire the asset and make it ready for intended use. 2. Useful life: estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence. 3. Residual value: estimate of the assets value at the end of its useful life. Slide 19 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. Slide 20 DELIVERY TRUCK DATA To facilitate the comparison of the three amortization methods, we will base all computations on the following data applicable to a small delivery truck purchased by Kims Florists on January 1, 2002. Slide 21 Under the straight-line method, amortization is the same for each year of the assets useful life. It is measured solely by the passage of time. In order to compute amortization expense, it is necessary to determine amortizable cost. Amortizable cost = Cost of Asset - Residual Value STRAIGHT-LINESTRAIGHT-LINE Slide 22 ILLUSTRATION 10-7 FORMULA FOR STRAIGHT-LINE METHOD The formula for computing annual amortization expense is: Amortizable Cost / Useful Life (in years) = Amortization Expense Cost Residual Value Amortizable Cost Useful Life (in Years) Amortization Expense Amortizable Cost $25,000 - $2,000 = $23,000 $23,000 5 = $4,600 Slide 23 DECLINING-BALANCEDECLINING-BALANCE The declining-balance method produces a decreasing annual amortization expense over the useful life of the asset. The calculation of periodic amortization is based on a declining book value (cost less accumulated amortization) of the asset. Annual amortization expense is calculated by multiplying the book value at the beginning of the year by the declining-balance amortization rate. The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Slide 24 The net book value for the first year is the cost of the asset since accumulated amortization has a zero balance at the beginning of the assets useful life. In subsequent years, net book value is the difference between cost and accumulated amortization at the beginning of the year. The formula for computing amortization expense is: DECLINING-BALANCEDECLINING-BALANCE Net Book Value (at beginning of year) Straight-line Rate (x declining balance rate multiplier, if any) Amortization Expense Slide 25 ILLUSTRATION 10-10 FORMULA FOR DECLINING-BALANCE METHOD Unlike the other amortization methods, salvage value is ignored in determining the amount to which the declining balance rate is applied. A common application of the declining-balance method is the double-declining-balance method, in which the declining-balance rate is double the straight-line rate. If Kims Florists uses the double-declining-balance method, the amortization is 40% (2 x the straight-line rate of 20%). Straight- Line Rate x2 Amortization Expense Amortizable Cost per Unit $25,000 x 40% = $10,000 Slide 26 Under the units-of-activity method, service life is expressed in terms of the total units of production or expected use from the asset, rather than time. The formulas for computing amortization expense are: Amortizable Cost / Total Units of Activity = Amortization Cost per Unit Amortization Cost per Unit * Units of Activity During the Year = Amortization Expense In using this method, it is often difficult to make a reasonable estimate of total activity. When the productivity of an asset varies significantly from one period to another, this method results in the best matching of expenses with revenues. UNITS-OF-ACTIVITYUNITS-OF-ACTIVITY Slide 27 ILLUSTRATION 10-12 FORMULA FOR 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. Amortized Cost Total Units of Activity Amortizable Cost per Unit $23,000 200,000 km = $0.115 Units of Activity during the Year Amortization Expense Amortizable Cost per Unit $0.115 x 30,000 km = $3,450 Slide 28 If wear and tear or obsolescence indicate that 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. Annu