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FINANCIAL ACCOUNTING A USER PERSPECTIVE. Hoskin • Fizzell • Davidson Second Canadian Edition. Capital Assets. Chapter Eight. Capital Asset Recognition. Capital assets Used to generate revenue over several periods in the future Used until replaced with a new asset

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financial accounting a user perspective

FINANCIAL ACCOUNTINGA USER PERSPECTIVE

Hoskin • Fizzell • Davidson

Second Canadian Edition

capital assets

Capital Assets

Chapter Eight

capital asset recognition
Capital Asset Recognition
  • Capital assets
    • Used to generate revenue over several periods in the future
    • Used until replaced with a new asset
    • Can have residual (or resale) value
capital asset valuation
Capital Asset Valuation
  • Historical cost
    • Original cost of the asset
    • Expensed (amortized) over the period used
capital asset valuation5
Capital Asset Valuation
  • Gain or loss on sale
    • Recognized only when sold
    • Difference between proceeds of the sale and the net book value
  • Net book value (or carrying value)
    • Original cost less amortization
capital asset valuation6
Capital Asset Valuation
  • Market value
    • Replacement cost
      • Amount that would be needed to acquire an equivalent asset
    • Net realizable value
      • Amount that could be received by converting the asset to cash
capital asset valuation7
Capital Asset Valuation
  • Canadian practice
    • Uses historical cost
    • Amortized over the period of use
      • Maximum of 40 years
    • Market value changes generally not recognized
capitalizable costs
Capitalizable Costs
  • Costs to acquire and prepare the asset for use
    • Purchase price (less any discounts)
    • Installation costs
    • Transportation costs
    • Legal costs
    • Direct taxes
basket purchases
Basket Purchases
  • Several assets acquires in one transaction
  • Price paid is divided between the assets on the basis of their relative fair values at the time of acquisition
basket purchases10
Basket Purchases

Timberland Example

interest capitalization
Interest Capitalization
  • Companies often borrow money to finance a capital asset
  • Interest paid on borrowed money
    • Capitalized when it is included in the capital asset account rather than being expensed
amortization or depreciation
Amortization (or Depreciation)
  • Method for allocating the cost of capital assets to the periods in which the benefits from the assets are received (the useful life)
  • Does not refer to the value of the asset
  • Follows the matching concept
amortization methods
Amortization Methods
  • Straight-line method
  • Accelerated or diminishing balance method
  • Decelerated method
  • Unit of production method
amortization methods14
Amortization Methods

Asset Carrying Value

Dol

lars

amortization methods15
Amortization Methods

Amortization Expense

Do

l

lars

straight line method
Straight-Line Method
  • Allocates the cost evenly over the life of the asset
  • Estimates needed for
    • Useful life
    • Residual value
straight line method17
Straight-Line Method
  • Assumptions:
    • Original Cost $10,000
    • Estimated
      • Residual Value $1,000
      • Useful Life 5 years
straight line method18
Straight-Line Method

-

Original Cost

Residual Value

Amortization Expense

=

Useful Life

-

$10,000

$1,000

=

5 years

=

$1,800 per year

straight line method19
Straight-Line Method

Amortization Schedule

accelerated methods
Accelerated Methods
  • Amortization
    • Multiply the carrying value of the asset by a fixed percentage
  • Carrying value decreases each year
  • Amortization expenses decreases each year
accelerated methods21
Accelerated Methods
  • Percentage rates
    • Lower when asset has longer life
  • Double declining balance method
    • Percentage is double the straight-line rate
    • Residual value
      • Not used for computations
      • Serves as a constraint
double declining balance method
Double Declining Balance Method
  • Assumptions:
    • Original Cost $10,000
    • Estimated
      • Residual Value $1,000
      • Useful Life 5 years
    • 200% Declining Balance Method
double declining balance method23
Double Declining Balance Method
  • Calculation:

DB rate = DB% x SL rate

= 200% x 1/n

= 200% x 1/5

= 40%

double declining balance method24
Double Declining Balance Method

Amortization Schedule

production method
Production Method
  • Assumptions
    • Benefits derived are related to the output or use of an asset
  • Requires that the useful life can be expressed as units of output
production method26
Production Method
  • Assumptions:
    • Original Cost $10,000
    • Estimated Residual Value $1,000
    • Estimated Usage
production method27
Production Method

-

Cost

Residual Value

Amortization Expense per Unit

=

Estimated Total Units of Output

-

$10,000

$1,000

=

20,000 units

=

$0.45 per unit

production methods
Production Methods

Amortization Schedule

recording amortization expense
Recording Amortization Expense
  • All amortization methods:

SE-Amortization expense XX

XA-Accumulated amortization XX

corporate income taxes
Corporate Income Taxes
  • Revenue Canada
    • Amortization expense is allowed to be deducted to calculate accounting income
    • Capital cost allowance (CCA) instead must be used to calculate taxable income
corporate income taxes31
Corporate Income Taxes
  • May result in a temporary difference betweenAccounting income and taxable income
  • Result is a future tax asset or liability (formerly referred to as deferred tax)
capital cost allowance cca
Capital Cost Allowance (CCA)
  • Capital assets are grouped into classes and assigned a maximum rate
    • Vehicles: Class 10: rate 30%
    • Equipment: Class 8: rate 20%
capital cost allowance cca33
Capital Cost Allowance (CCA)
  • Companies may deduct any part of the undepreciated capital costs (UCC) in the class up to the stated maximum
  • Exception:
    • Year of acquisition: 50% of normal amount
capital cost allowance cca34
Capital Cost Allowance (CCA)
  • Central Corp. purchases new equipment (Class 8) at a cost of $20,000
  • CCA

Year 1: 50% x $20,000 x 20% = $2,000

Year 2: 20% x ($20,000-$2,000)= $3,600

Year 3: 20% x ($20,000-$2,000-$3,600) = $2,880

capital cost allowance cca35
Capital Cost Allowance (CCA)
  • Journal entry:

SE-Tax expense 11,460

A-Future tax asset* 90

L-Income taxes payable 11,550

*(Future tax liability if a credit balance)

changes in amortization estimates and methods
Changes in Amortization Estimates and Methods
  • Estimates of useful life and residual value may change over time
  • Amortization may change as a result
changes in amortization estimates and methods37
Changes in Amortization Estimates and Methods
  • Straight-Line Method Assumptions
    • Original Cost $10,000
    • Residual Value $1,000
    • Useful Life 5 years
  • Changes in Year 4 (Estimations)
      • Remaining Useful Life 3 years
      • Residual Value $ 400
changes in amortization estimates and methods38
Changes in Amortization Estimates and Methods

Remaining Book Value

-

Residual Value

Amortization Expense

=

Useful Life

-

$4,600

$400

=

3 years

=

$1,400 per year

sale of capital assets
Sale of Capital Assets
  • Original cost and accumulated amortization removed from accounts
  • Gain or loss: difference between cash received and book value

A-Cash 1,200

XA-Accumulated amortization 9,000

A-Property, plant and equipment 10,000

SE-Gain on sale of PP&E 200

disposal of capital assets
Disposal of Capital Assets
  • If assets are disposed of and no cash is received

XA-Accumulated amortization 9,000

SE-Loss on disposal of PP&E 1,000

A-Property, plant and equipment 10,000

writedown of capital assets
Writedown of Capital Assets
  • If future recoverable amount of a capital asset declines below its carrying value

SE-Loss due to damage to asset 1,000

XA-Accumulated amortization 1,000

natural resources
Natural Resources
  • Capitalizing the costs implies that they have future value
  • Example: oil exploration
  • Exploration costs choices
    • Full costing method
    • Successful efforts method
intangible assets
Intangible Assets
  • Intangible assets have probable future value but no physical form
  • Guidelines:
    • If developed internally, expense as incurred
    • If purchased, can be capitalized
intangible assets45
Intangible Assets
  • Estimate useful life and residual value (if any)
  • Use straight-line method to amortize

SE-Amortization expense XX

A-Patents XX

intangible assets46
Intangible Assets
  • Advertising
    • Generally expensed as incurred
  • Patents, Trademarks, Copyrights
    • Legal life is the maximum for amortizing
  • Goodwill
    • Capitalize and amortize if purchased
slide47

Return on Assets

Net income before interest

ROA

=

Average total assets

Net income + [Interest expense x (1-Tax rate)]

=

Average total assets

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