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Acquiring Plant Assets

Acquiring Plant Assets. Long-term operational assets Assets that last for more than one accounting period Used to help a business generate revenue Types of long-lived assets Tangible assets Property, plant, and equipment Intangible assets Trademarks, patents, copyrights, etc.

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Acquiring Plant Assets

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  1. Acquiring Plant Assets • Long-term operational assets • Assets that last for more than one accounting period • Used to help a business generate revenue • Types of long-lived assets • Tangible assets • Property, plant, and equipment • Intangible assets • Trademarks, patents, copyrights, etc.

  2. Acquisition Costs • Historical cost principle requires assets to be recorded at their cost • Plus cost of getting asset in place and ready for use

  3. Basket Purchase Allocation • Purchase of two or more assets for one price • Cost allocated to each asset based on their relative fair market values • Percent of total FMV of the assets

  4. Basket Purchase Example • On July 1, Valdez Environmental purchased a tug boat and oil cleaning equipment for $7M • FMV of tug boat is $4M • FMV of oil cleaning equipment is $6M • How much of the $7M will be allocated to the tug boat and to the oil cleaning equipment?

  5. Depreciation and Depletion • Purchase of long-term tangible assets are capitalized (recorded as assets) • L-T tangible assets expensed by depreciating (or depleting) them • Depreciation allocates the COST of an asset to the periods that benefit from the use of the asset

  6. Depreciation and Depletion • Depreciation terminology • Acquisition cost (cost) • Estimated useful life • Salvage value (residual value) • Estimated value of an asset at the end of its useful life • Depreciable base = cost - salvage value • Book value (carrying value)

  7. Depreciation and Depletion • Depreciation methods • Straight-line • Activity (units of production) • Declining balance • Depletion

  8. Straight line Depreciation • Equal amount of an asset are expensed each year • Depreciable base is constant (cost-SV) • Depreciation rate is constant (1/UL) Depreciable cost (cost - SV) Useful life (in years)

  9. Activity (Units of Production) Depreciation • Amount of asset expensed each year depends on asset’s usage • Depreciable base is constant (cost-SV) • Depreciation rate is constant (1/UL) Depreciable cost (cost - SV) Useful life in units • Annual depreciation expense • depr rate x actual level of activity for year Depr Rate =

  10. Declining Balance Depreciation • Accelerated depreciation method • Annual depreciation expense declines over asset’s useful life • Depreciable base changes (beg book value) • Depreciation rate is constant (X/UL) • X = Depreciation rate • Most common rate is 200% • Also called double-declining balance (DDB) • Never depreciate below salvage value

  11. Depreciation Example • Photocopier purchased on 1/1/08 • Acquisition cost $14,000 • Useful life • 5 years or • 300,000 copies • Estimated salvage value $2,000

  12. Depreciation Example • Straight-line method $14,000 - $2,000 5 years • Activity method • Assume 40,000 copies were made $14,000 - $2,000 300,000 copies =$2,400/year x 40,000 =$1,600

  13. Depreciation Example • Double-declining balance method • Year 1 • Year 2 2 _ 5 yrs x $14,000 = $5,600 2 _ 5 yrs x ($14,000 - $5,600) = $3,360

  14. Depletion • Used to expense natural resources as they are used up • Same computation to activity depreciation with zero salvage value Cost _ Useful life in units • Annual depletion expense • depl rate x actual level of activity for year Depl rate =

  15. Using Intangible Assets:Amortization • Rights, privileges, or benefits that have long-term value to the firm • Recorded at cost • Amortization • Same method of expensing as straight-line depreciation with zero salvage value • Accumulated amortization calculated for each intangible asset

  16. Using Intangible Assets: Amortization • Copyright • Provides U.S. legal protection for authors of original work • Amortized over shorter of legal or useful life • Patent • A property right on inventions • Amortized over shorter of legal life (20 years) or useful life (often around 10 years)

  17. Using Intangible Assets: Amortization • Trademarks • 10 years of protection; renewable • Franchise • Agreement that authorizes someone to sell or distribute a company’s goods or services in a certain area • Goodwill • Research and development costs • Immediately expensed.

  18. Changes After an Asset Purchase • Asset impairment • Permanent reduction in market value below book value • Similar to LCM method for inventory • Capital expenditures to improve or extend an asset’s useful life • Capitalize and depreciate • Revising estimates of useful life and salvage value • Depreciate remaining depreciable cost over remaining useful life

  19. Revising an Estimate Example • Facts • Asset cost: $30,000 • Original useful life: 5 years • Original salvage value: $8,000 • In the beginning of year 3, the asset is determined to have 4 years of useful life remaining and a salvage value of $6,000

  20. Revising an Estimate Example • Depreciation expense for yr 1 & 2 • ($30,000 - $8,000)/5 = $4,400/yr • Book value at beginning of year 3 • ($30,000 - $8,800) = $21,200 • Depreciation expense yr 3-6 • ($21,200 - $6000)/4 = $3,800/yr • 4 =remaining years of useful life

  21. Selling Long-term Assets • Cash proceeds > BV = gain • Cash proceeds < BV = loss • Cash proceeds = BV = no gain/loss • Journal entry • Increase cash (debit) • Remove asset (credit) • Remove A/D (debit) • Record gain (credit) or loss (debit)

  22. Financial Statement Analysis • Return on assets (ROA) • Measures how well a company is using its assets to generate revenue • Answers the following • Did the company invest wisely in its assets? Net Income + Interest Expense Average Total Assets • Avg total assets = (Beg TA + End TA)/2

  23. Financial Statement Analysis • Asset Turnover Ratio • Measures how efficiently a company uses its assets to generate sales Net Sales _ Average Total Assets • Explain how a company can have a high asset turnover and a low ROA

  24. Business Risk, Control, and Ethics • Risks associated with long-term assets • Theft, vandalism, natural disasters, terrorist attacks, etc. • Controls used to safeguard assets • Physical controls • Complete and reliable record keeping

  25. Business Risk, Control, and Ethics • Controls used to safeguard assets (continued) • Monitoring • Make sure that physical controls, separation of duties, and other policies and procedures related to protecting assets are operating properly • Who is responsible for monitoring function?

  26. Assign #1: pg. 421-424 - E8-1A, E8-2A, E8-18A - (due 4/2) Assign #2: pg. 428-429 - P8-1A, P8-2A - (due 4/4)

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