Unit 1 week 1 Lecture and Notes

Define, Explain, and Provide Examples of Current and Noncurrent Assets, Current and Noncurrent Liabilities, Equity, Revenues, and Expenses

Current versus noncurrent distinction

• An asset that will be used or consumed in one year or less will be classified as a current asset. If the asset will be used or consumed over more than one year, it is classified as a noncurrent asset.
• A liability that will be settled in one year or less (generally) is classified as a current liability, while a liability that is expected to be settled in more than one year is classified as a noncurrent liability.

Equity and Legal Structure

Balance Sheet Equation (Accounting Equation)

Notice that assets have the + sign (increases) on the right side of the columns, while liabilities and owner’s equity have the + sign (increases) on the left side of the columns.

Distinguish between Tangible and Intangible Assets

Assets

• Are items a business owns
• Categorized as current or long-term
  • Assets that are expected to be used by the business for more than one year are considered long-term assets; all others are current.
    • Long-term assets are not intended for resale.
    • They are expected to help generate future revenue for the business.
• Are either tangible or intangible
  • Tangible: have physical substance—can be seen and touched
  • Intangible: assets used in the operations of the business that they do not intend to sell, but that do not have physical substance, such as patents, copyrights, trademarks, franchises
    

Property, Plant and Equipment

• physical substance (a definite size and shape),
• are used in the operations of a business,
• are not intended for sale to customers,
• are expected to be of use to the company for a number of years.

Intangible Assets

Are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance.

The value of intangible assets is very subjective. An intangible is usually not shown on the balance sheet until there is an event that indicates value objectively, such as the purchase of an intangible asset.

A company often records the costs of developing an intangible asset internally as expenses, not assets, especially if there is ambiguity in the expense amounts or economic life of the asset. There are conditions under which the costs can be allocated over the anticipated life of the asset.

Sample intangibles:

• Patent: a contract that provides a company exclusive rights to produce and sell a unique product for 20 years; right is granted by the federal government
• Copyright: the exclusive right to reproduce and sell artistic, literary, or musical compositions for the life of the author plus 70 years; right is granted by the federal government
• Trademark: the exclusive right to the name, term, or symbol a company uses to identify itself or its products for 10 years with optional 10-year renewable periods; right is granted by the federal government

Analyze and Classify Capitalized Costs versus Expenses

Long-term asset major categories:

• Property, plant, and equipment (fixed assets)
  • Asset that will be used in the business’s daily operation for years
  • Capitalized: asset is recorded as an asset and the cost is allocated over time through an expense account (i.e., depreciation expense) on the income statement 

• Investments
  • Asset that is not used in the day-to-day operations of the business
  • The company does not expect to use up the asset over time; rather the company hopes that the asset (investment) would grow in value over time.
  • Investments can be current or long-term assets.

• Repair and maintenance costs
  • Costs to keep an asset in working order
  • Expensed as incurred
  • Any adjustment/repair that does not extend the useful life of the asset beyond the original estimate, increase the capacity of the asset, or improve the quality of the asset is expensed.
  • If the adjustment/repair extends the useful life, increases the capacity of the asset, or improves the quality of the asset, that cost is capitalized and depreciated over the asset’s remaining life.

Determining the Cost of Fixed Assets

Land 

Costs include all necessary costs incurred in making the land ready for its intended use increase (debit) the Land account.

Costs typically include:

1. cash purchase price,
2. closing costs such as title and attorney’s fees,
3. real estate brokers’ commissions, and
4. accrued property taxes and other liens on the land assumed by the purchaser.

Buildings

Costs Include all costs related directly to purchase or construction.

Purchase costs:

• Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s commission.

Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing.

Construction costs:

• Contract price plus payments for architects’ fees, building permits, and excavation costs.

Equipment

Costs Include all costs incurred in acquiring the equipment and preparing it for use.

Costs typically include:

• Cash purchase price.
• Sales taxes.
• Freight charges.
• Insurance during transit paid by the purchaser.
• Expenditures required in assembling, installing, and testing the unit.

Explain and Apply Depreciation Methods to Allocate Capitalized Costs

Depreciation: the process of allocating the cost of a tangible asset to the periods in which that asset will be used to generate revenues

• There are several methods and we look at:
  • Straight-line
  • Units-of-production
  • Double-declining-balance

Depletion: the process of allocating the cost of natural resource to the periods in which that natural resource will produce revenues

Amortization: the process of allocating the cost of an intangible asset to the periods (useful or legal life) in which that intangible asset will be used to generate revenues

Components of Calculating Depreciation                                                                                      

Book value: the asset’s original cost less accumulated depreciation

Useful life: the length of time the asset will be productively used within operations

Salvage (residual) value: the price the asset will sell for or be worth as a trade-in when its useful life expires

Depreciable base (cost): the cost of the asset minus the salvage value, or the depreciation expense over the asset’s useful life

• Example: A truck was purchased for $10,000; $3,000 of depreciation has been recorded so far. The truck has a useful life of 6 years and a salvage value of $1,000. What is the depreciable base? What is the book value at this time? Book value = $10,000 – $3,000 = $7,000
• Depreciable base = $10,000 – $1,000 = $9,000

Straight -line Method

• Expense is same amount for each year.
• Depreciable cost = Cost less salvage value

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Units of Production (Units-of-Activity)

• Companies estimate total units of activity to calculate depreciation cost per unit.
• Expense varies based on units of activity.
• Depreciable cost is cost less salvage value.

Declining Balance (Double)

• Accelerated method.
• Decreasing annual depreciation expense over the asset’s useful life.
• Twice the straight-line rate with begin underline Double end underline -Declining-Balance.
• Rate applied to book value.

Describe Accounting for Intangible Assets and Record Related Transactions

Intangible assets

• Purchased intangibles are recorded at their acquisition cost.
  • Amortized over the useful or legal life of the asset
• Internally generated intangibles are expensed as the costs are incurred.

An exception is legal costs to register or defend an intangible asset. These costs are capitalized and amortized.

• Intangible assets are typically amortized using the straight-line method.
• There is typically no salvage value, and no accumulated amortization account is needed.
• Certain intangible assets are restricted and given limited life spans, while others are infinite in their economic life and not amortized.

 Limited-Life Intangibles:

• • • Amortize to expense.
    • Credit asset account.
  • Indefinite-Life Intangibles:
    • No foreseeable limit on time the asset is expected to provide cash flows.
    • No amortization.

Common types of intangible assets:

• Patents
  • Exclusive right to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant.
  • Capitalize costs of purchasing a patent and amortize over its 20-year life or its useful life, whichever is shorter.
  • Expense any R&D costs in developing a patent.
  • Legal fees incurred successfully defending a patent are capitalized to the Patent account.
• Copyrights
  • Give the owner the exclusive right to reproduce and sell an artistic or published work.
  • Extend for the life of the creator plus 70 years.
  • Cost of the copyright is the cost of acquiring and defending it.
  • Amortized to expense over useful life.
• Goodwill
  • Includes exceptional management, desirable location, good customer relations, skilled employees, high-quality products, etc.
  • Only recorded when an entire business is purchased.
  • Goodwill is recorded as the excess of purchase price over the fair value of the net assets acquired.
  • Not amortized.
• Trademarks and Trade Names
  • Word, phrase, jingle, or symbol that identifies a particular enterprise or product.
    • Wheaties, Monopoly, Kleenex, Coca-Cola, Big Mac, and Jeep.
  • Legal protection for indefinite number of 20 year renewal periods.
  • Capitalize acquisition costs.
  • No amortization.
• Franchises
  • Contractual arrangement between a franchisor and a franchisee.
    • Shell, Subway, and Rent-A-Wreck are franchises.
  • Franchise (or license) with a limited life should be amortized to expense over its useful life.
  • If the life is indefinite, the cost is not amortized.

Describe Some Special Issues in Accounting for Long-Term Assets

Depreciation and Income Taxes

I R S does not require taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements.
Taxpayers must use the straight-line method or a special accelerated-depreciation method called the Modified Accelerated Cost Recovery System (M A C R S).  
M A C R S is Not acceptable under G A A P. 

Revising Periodic Depreciation

• Accounted for in the period of change and future periods (Change in Estimate).
• No change in depreciation reported for prior years.
• Not considered an error.

Example  Tatooine HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been re corded for 7 years on a straight-line basis. In 2021 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. No journal entry is required to fix prior years After 7 years, a net book value needs to be established. We first calculate the accumulated depreciation for the first 7 years. Equipment Cost $510,000 Salvage value    -10,000 Depreciable base 500,000 Useful Life (original) $\div$  10 Years Annual depreciation 50,000 Years of depreciation X 7 years Accumulated depreciation $350,000 2. We reduce the equipment value by the amount of depreciation to obtain our net book value. Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000  3. We calculate the new depreciation Net book value $160,000 Salvage value (new) - 5,000 Depreciable base 155,000 Useful life remaining 8 years Annual depreciation $19,375

Selling an Asset  

• Tangible assets are assets that have physical substance.
• Long-term tangible assets are assets used in the normal course of operation of businesses that last for more than one year and are not intended to be resold.
• Examples of long-term tangible assets are land, building, and machinery.
• Intangible assets lack physical substance but often have value and legal rights and protections, and therefore are still assets to the firm.
• Examples of intangible assets are patents, trademarks, copyrights, and goodwill.
• Costs incurred to purchase an asset that will be used in the day-to-day operations of the business will be capitalized and then depreciated over the useful life of that asset.
• Costs incurred to purchase an asset that will not be used in the day-to-day operations, but was purchased for investment purposes, will be considered an investment asset.
• Fixed assets are recorded at the historical (initial) cost, including any costs to acquire the asset and get it ready for use.
• Depreciation is the process of allocating the cost of using a long-term asset over its anticipated economic (useful) life. To determine depreciation, one needs the fixed asset’s historical cost, salvage value, and useful life (in years or units).
• There are three main methods to calculate depreciation: the straight-line method, units-of-production method, and double-declining-balance method.
• Intangible assets are amortized over the life of the asset. Amortization is different from depreciation as there is typically no salvage value, the straight-line method is typically used, and no accumulated amortization account is required.
• Because estimates are used to calculate depreciation of fixed assets, sometimes adjustments may need to be made to the asset’s useful life or to its salvage value.
• Assets are sometimes sold before the end of their useful life. These sales can result in a gain, a loss, or neither, depending on the cash received and the asset’s net book value.