Chapter 8 - Reporting and Interpreting Long-Term Operational Assets

See above

See above

Cost or acquisition cost – the amount paid for the asset, including all amounts necessary to get the asset up and running.

Estimated useful life – how long the company plans to use the asset; may be measured in years or units that the asset will produce

Salvage Value or residual value – estimated value the asset will have when the company is done with it – it’s the market value on the disposal date.

Depreciable base = cost minus residual value.

Book value or carrying value = cost less accumulated depreciation taken to date.

Long-term assets, fixed assets, long-lived assets, and operating assets are used to describe assets that will be used for more than one accounting period.

Tangible assets – assets with physical substance – they can be seen and touched.

Intangible assets – rights, privileges, or benefits that result from owning long-lived assets that do not have physical substance.

A basket purchase is when two or more assets are acquired for a single price. A separate cost must be calculated for each asset using a relative fair market method. It is based on the assets’ individual market values

Capitalizing is recording a cost on the balance sheet as an asset rather than recording it as an expense.

Depreciation is the systematic allocation process to recognize the expense of long-term assets over the period in which the assets are used.

Amortization is the write-off of the cost of a long-term asset over more than one accounting period.

Depletion is the amortization of a natural resource.

Accountants use three common methods of depreciation for the financial statements: They are Straight-line depreciation, declining balance depreciation and the activity (units of production) method of depreciation

Straight-line depreciation is the method of depreciation in which equal amount of the cost of an asset are written off each year.
Depreciation expense = Acquisition cost – Salvage value divided by the estimated useful life in years.

Activity depreciation is the method of depreciation in which the useful life is expressed in terms of the total units of activity or production expected from the asset and the asset is written off in proportion to its activity during the accounting period.
Depreciation rate = acquisition cost – residual value divided by the estimated useful life in activity units.
Depreciation expense = depreciation rate times the actual activity level for the year.

Declining balance depreciation is an accelerated depreciation method.
Accelerated depreciation – methods in which larger amounts of the cost of an asset are written off early in the life off an asset and smaller amounts are written off later in the life of an asset.
Depreciation expense = existing book value times (2/estimated useful life in years)

Depletion applies to the writing off of the cost of natural resources such as oil wells and mines.
Depletion cost per unit = the cost of the natural resources less any residual value divided by the estimated units of activity.
Depletion expense = depletion cost times the units pumped, mined, or cut per period

Copyrights are a form of legal protection for authors of “original works of ownership” provided by U.S. law. Copyrights are amortized over their legal life, or useful life, whichever is smaller.

Patents are property rights that the U.S. government grants to an inventor “to exclude others from making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States” for a specific period of time. Patents are amortized over their useful life, or legal life, whichever is shorter.

Trademarks are symbols, words, phrases, or logos that legally distinguish one company’s product over any others. Trademarks are not amortized because the useful lives are indefinite.

Franchises are agreements that authorize someone to sell or distribute a company’s goods or services in a certain area. The franchise fee is amortized over the life of the franchise.

Goodwill is the excess cost over market value of the net assets when one company purchases another company. Goodwill is not amortized as it is assumed to have an indefinite life. It may be impaired and its value decreased under certain circumstances.

Research and Development (R&D) costs are expensed and not capitalized because it is not clear these costs represent Impairment is a permanent reduction in market value of an asset below its book value.

Capital expenditures are costs that will be recorded as assets, not expenses, at the time they are incurred. Examples include remodeling and improvements.

Ordinary repairs are expensed as they are routine and do not increase the useful life of the asset or its efficiency.

Sometimes revisions of useful lives and/or residual values must be made after an asset has been used. This is not treated as an error. The un-depreciated balance less the revised estimated residual value is spread over the remaining useful life.

Return on assets is a ratio that measures how well a company is using its assets to generate revenue. It is calculated by adding net income and interest expense and then dividing that sum by average total assets.

Asset turnover ratio measures how efficiently a company is using its assets. It is calculated by dividing net sales by average total assets.
A significant risk to long-term assets is that someone will steal one of those assets. Physical controls, such as locks, video camera, and security guards can be effective. Safeguarding assets through complete and reliable record keeping is also beneficial.