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Chapter 9 Long-Term Assets

The three categories of long term arrest are: (1) Plant Assets, (2) Natural Resources
and (3) Intangible Assets. With the exception of land, these assets will be written-off
over time by taking part of the cost from the balance sheet to the income statement
over some estimated period of time.

The definition of cost is extremely important: all expenditures reasonable and
necessary to get the asset in place and ready for its intended use. Realize that the
cost of a piece of equipment can include the cost of necessary changes to the building
(such as re-wiring), installation or set-up charges, and trial runs.

Pay very close attention to the items included in the cost of land, land improvements,
building, and equipment. Realize that land improvements is a separate asset account
because these items have an estimated useful life, is subject to wear and tear, and
therefore must be depreciated.

Once again the main issue revolves around FASBs matching rule; how much of the
assets cost to take to the income statement, and how much is deferred on the balance
sheet as carrying value.

Be careful with the word expenditure, it is not to be interpreted expense. Know the
two types of expenditures; a capital expenditure is debited to an asset account,
whereas a revenue expenditure is debited to an expense account. Understand the
ramifications of treating a capital expenditure as a revenue expenditure or vice- versa;
and what would motivate management to incorrectly classify one as the other.

Remember the definition of depreciation from chapter three is cost divided by an
estimated useful life. Because land does not have an estimated useful life, it is not
subject to depreciation.

When someone purchases a business, such as a McDonalds Restaurant for example,
what they are buying is in fact a group of assets. In order to record the transaction, the
value of each asset must be used to allocate the purchase price. It makes no
difference if the purchase price is more or less than the sum of the assets values.
Whatever percent each asset represents of the total value, that percent of the purchase
price will be allocated and debited to it.

Know how to calculate depreciation and carrying value under all three methods
presented.

The reason for estimating a salvage value when the asset is brand new is because we
cannot depreciate below the salvage value (aka residual value). In other words, the
residual value puts a limit on the amount of the assets cost that can be depreciated.
Thus cost less residual value equal depreciable cost. When an asset is fully
depreciated the remaining carrying value must equal the residual value.
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The Straight-Line Method spreads the depreciation evenly over the life of the asset.
Each year the depreciation expense will be the same. However, if the asset was not
used for the entire year, a pro-rated portion of depreciation will be taken for the first
year. For example if the asset was purchased on June 30, only 6 months depreciation
would be taken for the first year. Assuming the asset was purchased July 14
th
, 6
months depreciation would still be taken because we depreciate to the nearest full
month.

The Units-Of-activity Method spreads the depreciation evenly on a per unit basis. A
delivery truck for example would be depreciated so many cents per mile. Each year,
depreciation would be calculated by multiplying the amount per mile by the number
of miles the vehicle was driven.

The Double-Declining Balance Method is based on the assumption that when an
asset is new, it helps earn more revenues because it operates very efficiently.
However, when the asset gets older, it spends more time in the repair shop and thus
does not help generate as much revenue. Therefore, this method is said to provide a
better matching of revenues and expenses. A hint to remembering the steps for
calculating depreciation under this method is to relate the steps to the words in the
name. For example the word double relates to two times the straight-line rate, while
the word declining relates to the fact that the rate is multiplied by the carrying value,
which is less at the end of each period.

When an asset is fully depreciated as long as it is being used in the business it will
continue to be reported on the balance sheet, even if the carrying value is zero. The
only time the asset account and the related accumulated depreciation would be
removed from the books is when you get rid of the asset.

Disposal of Depreciable Assets The three ways to dispose of these assets are:
o Throw them out as having no value discard them.
o Sell them or
o Trade them same as Exchange

In all three instances it is necessary to do the following on the date of disposal:
1) Calculate and record any additional depreciation (remember depreciation
is usually recorded in an adjusting entry at the end of the year.) So if you
are disposing of the asset any time after January 15
th
, assuming a calendar
year, then additional depreciation will need to be recorded.
2) Calculate the carrying value of the asset at date of disposal.
3) Calculate any gain or loss on the transaction by comparing the asset you
receive on the disposal to the carrying value you are giving up. If the asset
received is greater than the carrying value, you have a gain (income
account credited). If the asset received is less than the carrying value you
have a loss (expense account debited). When you trade (exchange) the
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asset, the trade-in value is treated as the asset you receive on the
transaction.

Trading an asset for a similar asset The IRS rule says that when you trade an
asset for an asset that will continue doing the same job as the old asset (a computer
for a computer, or a car for a car), you are not really acquiring a new asset. Thus no
gain or loss can be recognized on a similar trade. FASB agrees with the IRS, but
because FASB had to remain consistent to its own convention of conservatism, we
are allowed to recognize a loss on a similar trade for financial reporting purposes, but
not a gain.

Accounting for Natural Resources The calculation of depletion is similar to the
production method of calculating depreciation. Because of the nature of this industry,
it is customary to deviate from traditional straight-line depreciation for fixed assets
such as building or equipment related to the extraction of the natural resources, and
depreciates them using the same percentage of the mineral that was depleted. This
way you will finish depreciating the fixed assets at the same time you finish depleting
the natural resource, thus providing a better matching of revenue and expenses.

Accounting for Intangible Assets The calculation of amortization is similar to the
straight-line method of calculating depreciation. However, the maximum number of
years to be used cannot exceed 40 according to FASB.

Ordinary repairs are necessary to maintain assets in good working condition and
does not increase residual value or extend the useful life. Examples for a vehicle are
oil change, tune-ups, new tires etc. Ordinary repairs are revenue expenditures and are
debited to an expense account as incurred.

Extraordinary repairs are repairs of a more significant nature that will either extend
the useful life or increase the residual value of the asset. Extraordinary repairs are
capital expenditures and are recorded by debiting the accumulated depreciation
account. The effect of this is to increase the remaining depreciable cost. Thus a new
calculation will have to be done for future depreciation.

The three methods of calculating depreciation previously covered in the chapter are
for financial statement purposes. The method of calculating depreciation for tax
purpose is the Modified Accelerated Cost Recovery System (MACRS). This
method cannot be used for financial reporting.

Do pay attention to the treatment of research and development costs, a major cost in
the technology industry. Because there is no guarantee that a saleable product will
emerge, these costs are expensed as incurred.