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Long-Lived Nonmonetary Assets and Their Amortization

Expenditure
Benefits beyond this period

Capitalize Asset Account 100

Expense Retained Earnings

20

100 20

1. Assets that provide services for several future years 2. An asset which is not easily convertible to cash or not expected to become cash within the next year

Types of Asset Tangible asset that has a physical substance Intangible asset that has no physical substance

Types of Asset Tangible


Land Plant and Equipment Natural Resources

Intangible
Goodwill Research and Development Cost Intellectual Property (Patent, Copyrights)

Non Current Assets are Recorded at Cost Distinction between Asset and Expense TYPE OF EXPENDITURE Low-cost items Betterment Repairs and Maintenance TREATMENT Expensed Capitalized Expensed

Method of Converting an Asset to Expense TYPE OF ASSET METHOD

Property Plant and Equipment Depreciation Natural Resource Depletion Intangible Assets Amortization

Items included in cost all expenditures that are necessary to make the asset ready for its intended use

Self-Constructed Assets
When a company constructs a building or item of equipment for its own use, the amount of capitalized cost includes all the costs incurred in construction Building Permits Architects Fees Contract Price Interest on financing

NonCash Costs

When a capital asset is purchased using non cash items such as a common stock, the value of the equipment company is recorded by: 1. The Fair Market Value of the consideration given 2. If the FMV of the consideration given is not feasible to determine its value, then the FMV of the new asset will be used.

Depreciation
The accounting process of this gradual conversion of plant and equipment capitalized cost into expense is called depreciation Original Cost Residual Value Dep Exp = -------------------------------------------------Service Life

Example:

Date of Purchase Equipment 7/1/2005 Cost P1,000,000 Useful Life 5 years Residual Value P 100,000

JE 1) 7/1/05

Equipment 1,000,000 Cash 1,000,000 to record purchase of equipment for cash

2) 12/31/05 Depreciation Expense 90,000 Accumulated Depreciation 90,000 to record depreciation of equipment

Annual Depreciation

1,000,000 - 100,000 = ------------------------------------------ = 180,000 5

Example: Date of Purchase Equipment 1/1/2005 Cost P1,000,000 Useful Life 5 years Residual Value P 100,000

Year Depreciation Accumulated Depreciation Net Book Value -----------------------------------------------------------------------------------------2005 180,000 180,000 820,000 2006 180.000 360,000 640,000 2007 180,000 540,000 460,000 2008 180,000 720,000 280,000 2009 180,000 900,000 100,000

Lapsing Schedule Year Depreciation Accumulated Depreciation Net Book Value -----------------------------------------------------------------------------------------2005 180,000 180,000 820,000 2006 180.000 360,000 640,000 2007 180,000 540,000 460,000 2008 180,000 720,000 280,000 2009 180,000 900,000 100,000

Equipment 1/1/05 1,000,000

Accumulated Depreciation

180,000 180,000

12/31/05 12/31/06

180,000
180,000 180,000

12/31/07
12/31/08 12/31/09

Balance Sheet Presentation

2009 2008 2007 2006 2005 ---------------------------------------------------------------------------------PPE 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Less Acc. Dep 900,000 720,000 540,000 360,000 180,000 -------------------------------------------------------------------Net Book Value 100,000 280,000 460,000 640,000 820,000 Income Statement Dep Exp 180,000 180,000 180,000 180,000 180,000

Methods of Depreciation 1. Straight Line Method 2. Double Declining Balance Method 3. Sum of the Years Digit

Straight Line Method Original Cost Residual Value Dep Exp = -------------------------------------------------Service Life Annual Depreciation Expense 1,000,000 - 100,000 = ------------------------------------------ = 180,000 5

Depreciation Rate = 180,000/1,000,000 x 100% = 18%

Double Declining Balance Method


a fixed rate is multiplied by the declining book value of the asset in order to arrive at the annual depreciation and the straight line rate is simply doubled to get the fixed rate If the Straight Line Depreciation Rate = 18% then Double Declining Balance Rate is = 36%

Date of Purchase Equipment 1/1/2005 Cost P1,000,000 Depreciation Rate 36% Useful Life 5 years Residual Value 100,000 Year Particular Depreciation Accumulated Depreciation Net Book Value ----------------------------------------------------------------------------------------------------------------2005 1,000,000 x 36% 360,000 360,000 640,000 2006 640,000 x 36% 230,400 590,400 409,600 2007 409,600 x 36% 147,456 737,856 262,144 2008 262,144 x 36% 94,372 832,228 167,772 2009 167,772 x 36% 67,772 900,000 100,000

Sum of the Years Digit Method provides for depreciation that is computed by multiplying the depreciable amount by a series of fractions whose: numerator is the digit in the life of the asset and denominator uses the sum of the digits of the life of the asset computed using the formula SYD = Life (Life+ 1) ------------------2

Date of Purchase Equipment 1/1/2005 Cost P1,000,000 SYD = 5 (5 + 1) = 15 Useful Life 5 years ------------Residual Value 100,000 2 Year Particular Depreciation Accumulated Depreciation Net Book Value ----------------------------------------------------------------------------------------------------------------2005 900,000 x 5/15 300,000 300,000 700,000 2006 900,000 x 4/15 240,000 540,000 460,000 2007 900,000 x 3/15 180,000 720,000 280,000 2008 900,000 x 2/15 120,000 840,000 160,000 2009 900,000 x 1/15 60,000 900,000 100,000

Annual Depreciation Charges for Equipment with Net Cost of 900,000 and 5 year service life

400,000 350,000 300,000 250,000 Straight Line 200,000 150,000 100,000 50,000 0 1 2 3 4 5 Double Declining SYD

Methods of Depreciation Straight Line Method

Double Declining Balance Method Sum of the Years Digit


Units of production method Working hours or service hours method

Plant and Equipment Disposal Suppose that at the end of 10 years Transtor Company sells its Building. At that time 10/40 of the original cost, or $250,000 would have been built up in Accumulated Depreciation account, and the net book value would be $750,000. If the building is sold for $ 750,000, the account is charged as follows: Cash 750,000 Accumulated Dep 250,000 Building 1,000,000 to record the sale of building

Plant and Equipment Disposal Suppose that at the end of 10 years Transtor Company sells its Building. At that time 10/40 of the original cost, or $250,000 would have been built up in Accumulated Depreciation account, and the net book value would be $750,000. If the building is sold for $ 650,000, the account is charged as follows:

Cash 650,000 Accumulated Dep 250,000 Loss on Sale 100,000 Building 1,000,000 to record the sale of building

Plant and Equipment Disposal Suppose that at the end of 10 years Transtor Company sells its Building. At that time 10/40 of the original cost, or $250,000 would have been built up in Accumulated Depreciation account, and the net book value would be $750,000. If the building is sold for $ 850,000, the account is charged as follows: Cash 850,000 Accumulated Dep 250,000 Building 1,000,000
Gain on Sale 100,000

to record the sale of building

Exchanges and Trade-Ins Some items of property and equipment are disposed of by trading them in or exchanging them for new assets. The amount used in this calculation depends on whether or not the traded asset is similar to the new asset.

Trade In of Similar Assets

Cost of New Asset Net Book Value of the asset given + cash payment Fair value of the asset given + cash payment

Dissimilar Assets

Assume a company trades in two automobiles, each of which originally costs $20,000, of which $15,000, each has a net book value of $5,000. Each has a fair value of $7,000 as a used car. The fist automobile is traded for another automobile that also has a list price of $30,000 and $18,000 is given to the dealer in addition to the trade-in. Automobile (New) 23,000 Accumulated Depreciation 15,000 Cash 18,000 Automobile (Old) 20,000 to record trade-in of similar assets Value of New Automobile = 5,000 + 18,000

Assume a company trades in two automobiles, each of which originally costs $20,000, of which $15,000, each has a net book value of $5,000. Each has a fair value of $7,000 as a used car. The second automobile is traded for a piece of equipment that also has a list price of $30,000 and $18,000 cash is given in addition to the trade in. Equipment (New) 25,000 Accumulated Depreciation 15,000 Cash 18,000 Automobile (Old) 20,000 Gain on disposal 2,000 to record trade-in of dissimilar assets Value of New Automobile = 7,000 + 18,000

Amortization
is the systematic allocation of the cost or revalued amount of an intangible asset less any residual value, as an expense over the assets useful life. Amortization of Intangible Asset Intangible Asset xxxxx xxxxx

to record the amortization of intangible asset

Depletion
as an accounting procedure is the systematic allocation of the cost of a natural resource over the periods benefited

Entry to record depletion Depletion xxxx Accumulated Depletion

xxxx

Problem 7-2 Higher company had the following disposals during 2006:

Equipment ID Number 301 415 573

Purchase Date 2/18/1998 7/3/2005 6/15/2004

Origina l Cost 70,300 96,000 95,400

Date of Disposal 10/3/2002 7/19/2008 3/21/2002

Disposal Proceeds 14,300 63,000 38,000

Useful Life 10 5 6

Depreciation Method Straight line 150% declining Balance Sum of the Year's Digit

Highers policy is to charge a full years depreciation in the year of purchase if an asset is purchased before July 1.For assets purchased after July 1, only years depreciation is charged. During the year of disposal, years depreciation is charged is the asset is sold after June 30. No depreciation is charged during the year of disposal if the asset of sold before July 1.In all the cases above , estimated residual value at the time of the acquisition was zero.

Problem 7-2

Equipment
ID Number 301

Purchase
Date 2/18/1998

Origina l Cost 70,300

Date of
Disposal 10/3/2002

Disposal
Proceeds 14,300

Usefu l Life 10

Depreciation
Method Straight line

Annual Depreciation = 70,300 / 10 = 7,030 Year Depreciation Expense : 1998 7,030 1999 7,030 2000 7,030 2001 7,030 2002 3,515 -----------------------31,365

Entry: Cash 14,300 Accumulated Depreciation 31,365 Loss on Disposal 24,635 Equipment 70,300 to record disposal of equipment

Cost Less: Accumulated Depreciation Net Book Value Proceeds Loss on Sale

70,300 31,365 38,935 14,300 24,635

Problem 7-2

Equipme nt

Purcha se

Origin al Date of

Disposal

Usef ul
Life

Depreciation Method

ID Straight Line Depreciation Rate = 96,000/5 Cost = 20% Number Date 415 7/3/200 5

150% Declining Balance Rate = 20% x 150% = 30%

Dispos al Proceeds

96,00 7/19/20 150% declining 0 Depreciatio63,000 08 5 AccumulateBalance Book Net

Year

Particulars

d Depreciatio n

Value

200 5 200 6

96,00 0 x 81,60 0 x

30 % /2 14,400 30 % 24,480 17,136

14,400
38,880
To compute for the gain/loss on the disposal: Net book Value 33,986 56,016 Disposal Proceeds 63,000 ------------Gain on Sale 29,014

81,600
57,120 39,984

Entry: 200 57,12 63,000 30 Cash Accumulated Depreciationx 7 0 62,014 96,000 % Equipment Gain on Disposal 29,014 200 to record disposal of equipment 39,98 30

4 x

% /2 5,998

62,014

33,986

Problem 7-2
Equipment
ID Number

Purchase
Date

Origina l Cost

Date of Disposa l

Disposal
Proceeds

Usefu l Life

Depreciation
Method

SYD = 6 (6+1) = 21 Yea 3/21/200 ------------ 6/15/2004 r95,400 573 7 Particulars 2

Depreciati Accumulat Net Book 38,000 6 Sum of the Year's Digit on ed Value Depreciati on 27,257 22,714 27,257 49,971 68,143 45,429

200 95,40 6/2 5 0 x 1


200 95,40 5/2 6 0 x 1

Entry: Cash 38,000 Accumulated Depreciation 45,429 Loss on Disposal 11,971 Equipment 95,400 to record disposal of equipment

200 95,40 4/2 7 0 x 1

49,971 45,429 To compute for the gain/loss on the disposal:

Net book Value 52,971 Disposal Proceeds 38,000 ------------Gain on Sale 11,971

Problem 7-5 Cleanburn Coal Company


Property Plant and Equipment Machinery Building Equipment

Cost Acquisition Cost Exploration Costs Soil test of the purchased land Soil tests of other sites Test Permits Development Cost Clearing of site Storage Facilities and Office Machinery TOTAL 21,700,000

Natural Resource 21,700,000

35,250 116,250 41,000

35,250 116,250 41,000

387,500 291,250 1,162,500 23,733,750

387,500 291,250 22,280,000 291,250 1,162,500 1,162,500

Problem 7-5 Cleanburn Coal Company


Property Plant and Equipment Machinery Building Equipment 22,280,000 291,250 1,162,500

Cost TOTAL 23,733,750

Natural Resource

To compute for the depletion rate per unit: = Cost of Natural Resource-Salvage Value/Estimated number of units to be extracted = P22,280,000 -2,325,000/ 800,000 tons of coal = P24.94 per ton

Year Units Extracted Depletion Rate 1 30,000 24.94 2 70,000 24.94 3 70,000 24.94 170,000.00

Depletion Accumulated Depletion 748,200.00 748,200.00 1,745,800.00 2,494,000.00 1,745,800.00 4,239,800.00 4,239,800.00

Problem 7-5 Cleanburn Coal Company


Property Plant and Equipment Machinery Building Equipment 22,280,000 291,250 1,162,500

Cost TOTAL 23,733,750

Natural Resource

To compute for the depreciation: Using the straight line method for the Building Annual Depreciation Expense = 291,250/10 years = 29,125 Using the sum of the years digit = 10(10+1) ----------------2 = 55

Year 1 2 3

Building Machinery Equipment SYD Computation 29,125.00 211,363.36 (10/55 x 1,162,500) 29,125.00 190,277.73 ( 9/55 x 1,162,500) 29,125.00 160,090.91 ( 8/55 x 1,162,500) 87,375.00 561,732.00

Case 7-2 Joan Holtz (c) 1)


a. Architect's Fees b. Cost of Snow Removal during construction c. Cash discounts eraned for prompt payment on materials purchased for construction d The cost of building a combined construction office and toolshed that would be torn down once the factory wing had been completed e Interest earned on money borrowed to finance construction Capitalized as part of the cost of the additional wing Capitalized as part of the cost of the additional wing Deducted from the cost of building Capitalized as part of the cost of the additional wing

Interest incurred during the construction period is capitalized and the remaining intrest cost is expensed

Case 7-2 Joan Holtz (c)

g h i

Local real estate taxes for the period of construction on the portion of land to be occupied on by the new wing The cost of mistakes made during construction The Overhead costs of the maintenance department The cost of insurance during construction Cost of damages and losses on any injuries not covered by insurance

Capitalized as part of the cost of the additional wing Capitalized as part of the cost of the additional wing Expensed Expensed Expensed

Case 7-2 Joan Holtz (c) 2)


A. When Archer company bought a piece of land, including the buildings thereon,( in other words the land and the building is bought at a single cost) and Archer company bought the property with the INTENTION of the razing the building, the cost of the building will be attributed to the cost of the Land B. and its Costs for demolishing the old building to make room for a new building will be part of the cost of the land account. C. ref a) If a company owned this piece of land, with buildings there on, the cost of the land and the cost of the building will be booked separately. b) and if the company later decides to have the buildings razed to make room for a construction of a new building, then the net book value of the old building , if any, and the net cost of demolishing the building should be charged to loss on retirement of the old building. The cost of demolishing the old building cannot be charged to the cost of the new building because this Is part of the service cost related to the old building when retired from use.and

Case 7-2 Joan Holtz (c) 3)


A. The governing principle is that cost of an item or property, plant, or equipment includes all expenditures that are necessary to make an asset ready for its intended use. Since the installation of additional beams is necessary to make the machine ready for its intended use, then the cost will form part on the cost of the new machine B. Same answer with A.

C. No, sales related taxes will NOT form part on the cost of the machine
D. This will be classified as trade-in of similar assets, no gain or loss is recognized since an exchange of similar assets does not result in the culmination of an earning process.

Case 7-2 Joan Holtz (c) 4)


Question: How will the cost on the application engineering on leased computers be treated? Answer : Since the installation is necessary to make the computer ready for its intended use, then its cost will be capitalized and be amortized over the lease period.

Case 7-2 Joan Holtz (c) 5)


Question: The company have capitalizing all the costs, estimated at $500,000, that made the manufacturing equipment ready for its intended use. And the engineers believed that at least $50,000 of additional debugging, fine tuning and testing would be required for the equipment to reach the 65 ppm quality standard. 1) Should the additional $50,000 be capitalized, despite the fact that the equipment was already earning? Answer :The additional $50,000 will be added to the cost of the asset, since this additional expenditure will increase the quality of output that the equipment will produce. 2) If so, should the amount of depreciation for the initial production periods be adjusted? Answer: No. The cost of a betterment which is a new unit is depreciated over the remaining life of the equipment .