Financial accounting a user perspective
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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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Hoskin • Fizzell • Davidson

Second Canadian Edition

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Capital Assets

Chapter Eight

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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

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Capital Asset Valuation

  • Historical cost

    • Original cost of the asset

    • Expensed (amortized) over the period used

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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

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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

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Capital Asset Valuation

  • Canadian practice

    • Uses historical cost

    • Amortized over the period of use

      • Maximum of 40 years

    • Market value changes generally not recognized

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Capitalizable Costs

  • Costs to acquire and prepare the asset for use

    • Purchase price (less any discounts)

    • Installation costs

    • Transportation costs

    • Legal costs

    • Direct taxes

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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

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Basket Purchases

Timberland Example

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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

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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

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Amortization Methods

  • Straight-line method

  • Accelerated or diminishing balance method

  • Decelerated method

  • Unit of production method

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Amortization Methods

Asset Carrying Value



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Amortization Methods

Amortization Expense




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Straight-Line Method

  • Allocates the cost evenly over the life of the asset

  • Estimates needed for

    • Useful life

    • Residual value

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Straight-Line Method

  • Assumptions:

    • Original Cost $10,000

    • Estimated

      • Residual Value $1,000

      • Useful Life 5 years

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Straight-Line Method


Original Cost

Residual Value

Amortization Expense


Useful Life





5 years


$1,800 per year

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Straight-Line Method

Amortization Schedule

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Accelerated Methods

  • Amortization

    • Multiply the carrying value of the asset by a fixed percentage

  • Carrying value decreases each year

  • Amortization expenses decreases each year

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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

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Double Declining Balance Method

  • Assumptions:

    • Original Cost $10,000

    • Estimated

      • Residual Value $1,000

      • Useful Life 5 years

    • 200% Declining Balance Method

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Double Declining Balance Method

  • Calculation:

    DB rate = DB% x SL rate

    = 200% x 1/n

    = 200% x 1/5

    = 40%

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Double Declining Balance Method

Amortization Schedule

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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

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Production Method

  • Assumptions:

    • Original Cost $10,000

    • Estimated Residual Value $1,000

    • Estimated Usage

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Production Method



Residual Value

Amortization Expense per Unit


Estimated Total Units of Output





20,000 units


$0.45 per unit

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Production Methods

Amortization Schedule

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Recording Amortization Expense

  • All amortization methods:

    SE-Amortization expense XX

    XA-Accumulated amortization XX

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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

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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)

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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%

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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

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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

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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)

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Changes in Amortization Estimates and Methods

  • Estimates of useful life and residual value may change over time

  • Amortization may change as a result

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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

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Changes in Amortization Estimates and Methods

Remaining Book Value


Residual Value

Amortization Expense


Useful Life





3 years


$1,400 per year

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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

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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

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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

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Natural Resources

  • Capitalizing the costs implies that they have future value

  • Example: oil exploration

  • Exploration costs choices

    • Full costing method

    • Successful efforts method

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Intangible Assets

  • Intangible assets have probable future value but no physical form

  • Guidelines:

    • If developed internally, expense as incurred

    • If purchased, can be capitalized

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Intangible Assets

  • Estimate useful life and residual value (if any)

  • Use straight-line method to amortize

    SE-Amortization expense XX

    A-Patents XX

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Intangible Assets

  • Advertising

    • Generally expensed as incurred

  • Patents, Trademarks, Copyrights

    • Legal life is the maximum for amortizing

  • Goodwill

    • Capitalize and amortize if purchased

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Return on Assets

Net income before interest



Average total assets

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


Average total assets