joan holtz c

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Depreciation Accounting
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Types of Long-Lived Assets

• Tangible asset
• Asset with physical substance
• Property, plant, and equipment fixed asset.
• Intangible asset
• Intellectual property.
• No physical substance
• Examples are patent rights, copyrights

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Amortization

• View capital asset as bundle of services
• Similar to prepaid expenses, cost is expensed as
  company benefits from the services
• Land - no depreciation
• Plant and equipment - depreciation
• Natural resources - depletion
• Intangible assets - amortization

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Depreciation Methods

• Straight line method
• (original cost - residual value) /service life
• Accelerated methods
• Declining balance methods
• Sum of the years or years digits methods

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Declining Balance Method

• Depreciation book value depreciation rate.
• Double declining balance method book value 2
  straight line rate.
• Straight line rate 1/(life of asset in years).

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Impaired Assets

• An asset for which its remaining benefits, as
  measured by the sum of future cash flows the
  assets use will generate, is less than its book
  value
• If entity expects to hold asset
• Write asset down to fair value
• If entity expects to sell asset
• Write asset down to lower of cost or fair value
  less cost of disposal.

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Group Depreciation

• Group depreciation
• Treats all similar assets as a pool or group
  rather than calculating for each item separately.
• No gain or loss recognized when an individual
  item is disposed.
• Credit asset account for original cost.
• Debit cash for amount of proceeds.
• Debit accumulated depreciation for difference.
• Accumulated depreciation
• Does not represent the accumulation of any
  tangible thing.
• Sum of the original cost that has been expensed.
• Funding the purchase of new assets is usually
  unrelated to depreciation

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Goodwill

• When one company buys another.
• Goodwill Purchase price of company fair value
  of net assets.
• Net assets include tangible assets and recognized
  intangible assets net of liabilities assumed by
  the purchaser.
• Recorded as an asset upon acquisition.
• Not amortized.
• Annual impairment test.
• Any write down is charged against income.

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Intangible Assets with Limited Lives

• Examples patents and copyrights
• If purchased, recorded at cost
• Amortized over useful life
• Useful life can equal or be shorter than legal
  life
• If developed internally, expense as incurred

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Stern Corporation (B)

• Case 7-1
• Page 210

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Stern Corporation

• Ascertaining the PPE and accumulated
  depreciation accounts
• Transactions..,
• Jan 2, 2006 Machine sold for its book value
  3,866 (Books record 31,233, Accumulated
  depreciation 27,367)
• End 2006 Decrease in tool inventory accounting
  to 7,850
• Mar 1, 2006 Sold Automobile for cash 2,336
  (Books record 8,354, Accumulated depreciation
  5,180, Net book value as of Jan 1, 2006 3,174)

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Stern Corporation

• Transaction
• Cost of patent written off as an expense over the
  reminder of its legal life as of Dec 31, 2005.
  Patents remaining legal life was 5 years
• July 1, 2006 Typewriter that had cost of 1,027
  and had been fully depreciated on Dec 31, 2005,
  was sold for 75
• Oct 1, 2006 company sold a desk for 80 (Book
  cost of 490 with an accumulated depreciation of
  395 as of Jan 1, 2006)

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Depreciation Rates

• Buildings 2
• Factory machinery 10
• Furniture and fixtures 10
• Automotive equipment 20
• Office machines 10
• Included in the factory machinery cost of
  3,425,585 was machine costing 85,000 that had
  been fully depreciated on Dec 21, 2005, and that
  was still in use

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Depreciation Accounting (AS 6)

• Assets not included for depreciation..,
• Forests
• Plantations
• Regenerative natural resources
• Wasting assets
• Expenditure on exploration for and extraction of
  minerals, oils, natural gas, similar non
  generative assets
• Expenditure on RD
• Goodwill
• Live stock
• Land with unlimited useful life for the
  enterprise

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Defined Terms

• Depreciation
• Measure of..,
• Wearing out / consumption / loss of value on
• Usage / effluxion of time / obsolescence through
  technology and market change
• Includes amortization of assets with
  predetermined useful life
• Depreciable asset
• Used more than one accounting period
• Having limited useful life
• Used for production or supply of goods and
  services

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Defined Terms

• Useful life
• Period of usage by firm
• No. of production or similar units expected to be
  obtained by suing the asset
• Depreciable amount
• historical cost estimated residual value

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Factors in Assessment of Depreciation

• Historical cost or revalued value of the asset
• Includes..,
• Acquisition
• Installation
• Commissioning
• Improvements
• May change due to..,
• Increase or decrease in LT liability on account
  of exchange fluctuations
• Price adjustments
• Changes in duties
• Changes in similar other factor

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Factors in Assessment of Depreciation

• Expected useful life of the depreciable asset
• Is shorter than physical life
• Predetermined by legal or contractual limits
• Directly governed by extraction or consumption
• Depends on operational factors usage
• Reduced by obsolescence due to..,
• Technological changes
• Improvement in production methods
• Change in market demand for the product or
  service output of the asset
• Legal or other restrictions
• Estimation purely based on..,
• Experience with similar type of assets
• Any addition or extension which retains a
  separate identity and is capable of being used
  after the existing asset is disposed of, is
  depreciated independently on the basis of an
  estimate of its own useful life

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Factors in Assessment of Depreciation

• Estimated Residual Value of the Depreciable Asset
• A difficult matter
• Estimated at time of acquisition / installation
  or at time of subsequent revaluation of the asset
• Basis of determination..,
• Realizable value of similar assets

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Depreciation

• Quantum of depreciation to be provided in an
  accounting period involves..,
• Exercise of judgment by management in light of..,
• Technical
• Commercial
• Accounting
• Legal requirements
• Need periodical review and revision

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Depreciation Methods

• Commonly employed method includes..,
• Straightline method
• Reducing balance method
• Factors in selection of method..,
• Type of asset
• Nature of use of such asset
• Circumstances prevailing in business
• Applied consistently to provide comparability
• Combination of more than method is sometimes used
• Depreciable assets which do not have material
  value, depreciation is often allocated fully in
  accounting period in which they are acquired

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Changing Depreciation Method

• Is treated as as a change in an accounting policy
• Change in method is allowed if..,
• Its required by statute
• Compliance with an AS
• Results in more appropriate preparation and
  presentation of financial statements
• On change in method
• Depreciation is calculated using new method from
  the date of asset coming into use
• Deficiency or surplus on change need to be
  adjusted during the year of change charged to
  PL statement

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Depreciation

• Companies Act 1956 lays down rates of
  depreciation in respect of various assets
• Estimates useful life of an asset is shorter than
  under the provision of relevant statute
• Depreciation provision computed by applying
  higher rate
• Depreciable assets are disposed / discarded /
  demolished / destroyed, the net surplus or
  deficiency, if material, is disclosed separately

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Depreciation Disclosure in Financial Statements

• Disclosure to be made includes..,
• Depreciation methods used
• Total depreciation for the periods for each class
  of assets
• Gross amount of each class of depreciable assets
• Related accumulated depreciation
• Assets depreciation rates and useful life are
  disclosed only of they are different from the
  principal rates specified in the statute
  governing the enterprise

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Accounting for Fixed Assets (AS 10)

• Fixed assets include..,
• Land
• Buildings
• Plant and machinery
• Vehicles
• Furniture and fittings
• Goodwill
• Patents
• Trade marks
• Designs

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Assets Excluded from AS 10

• Forests
• Plantations
• Regenerative natural resources
• Wasting rights..,
• Mineral rights
• Expenditures on exploration for extraction of
  minerals, oils, natural gas, and non-regenerative
  resources
• Expenditure on real estate development
• Livestock
• Government grants and subsidies
• Assets under leasing rights

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Definitions

• Fixed asset
• Used for producing and providing services
• Not held for sale
• Fair market value
• Price agreed in open unrestricted market between
  knowledgeable willing parties dealing at arms
  length
• Gross book value - historical cost

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Identification of Fixed Asset

• Judgment required
• Aggregate individually insignificant items, and
  to apply the criteria to aggregate value
• Stand-by equipment is capitalized
• Servicing equipment is capitalized
• General machinery spares charged to PL on
  consumption
• Any specific machinery spares which irregular in
  nature allocate over a period not exceeding
  useful life of the principal item
• Accounting can be improved if the total
  expenditure is allocated to component parts, when
  in practice separable, and estimates are made of
  useful lives of these components

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Components of Cost

• Purchase price
• Import duties
• Non-refundable taxes or levies
• Directly attributable cost in bringing the asset
  to its working condition..,
• Site preparation
• Initial delivery and handling costs
• Installation costs special foundations for
  plant
• Professional fees architect fees or engineers
  fees
• Deduct trade discount and rebates from purchase
  price
• Commissioning cost..,
• Expenditure on test runs
• Expenditure on experimental production

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Components of Cost

• Costs may undergo changes subsequent to
  acquisition due to..,
• Exchange fluctuations
• Price adjustments
• Changes in duties or similar factors
• Administration and general overheads expenses are
  excluded
• Any specific direct admin and OH expenses related
  to making the asset workable is included
• Expenses during prolonged period between
  installation and commercial start up
• Will be charged to PL statements
• Treated as deferred revenue expenditure amortized
  over a period not exceeding 3 to 5 years after
  commencement of commercial production

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Self-Constructed Fixed Assets

• Gross book value costs of construction
• Internal profit to be eliminated

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Non-Monetary Consideration

• FA acquired in exchange for another asset
• Cost of FA FMV of consideration given
• When asset is same cost net book value
• FA acquired in exchange for shares in the
  enterprise,
• Cost of FA FMV (or)
• Cost of FA FMV of shares

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Improvements and Repairs

• Improvement
• Expenditure increasing future benefits
• Added to gross book value
• Includes..,
• Addition
• Extension

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Amount Substituted for Historical Cost

• Methods valuing assets
• Can be restated by appraisal by competent valuer
• Indexation and reference to current prices
• Revalued amount is presented as..,
• Restating gross book value and accumulated
  depreciation net book value net revalued
  amount
• Restating the net book value by adding therein
  the net increase on account of revaluation
• Upward revaluation does not provide a basis for
  crediting to the PL statement the accumulated
  depreciation existing at the date of revaluation

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Amount Substituted for Historical Cost

• Different bases of valuation can be sued in same
  financial statements for..,
• Separate item in each of the categories of fixed
  assets
• Different categories of fixed assets
• Systematic basis of valuation is required when
  select assets are revalued
• Not appropriate to have revalued class of assets
  net book value more than recoverable amount of
  the assets of that class

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Amount Substituted for Historical Cost

• Increase in net book value on revaluation is
  directly credited to
• Owners account in the name revaluation reserve
• PL account, if earlier a revaluation loss is
  charged to PL account
• Any decrease in value charged to..,
• PL account
• Revaluation reserve, if there was charge in
  increase done earlier

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Retirement and Disposals

• On disposal the FA are eliminated from financial
  statements
• Assets retired from active use and held for
  disposal are stated at lower of net book value or
  realizable value, expected loss accounted in PL
  account
• Gain or loss on disposal of an asset in
  recognized in PL account in a historical cost
  financial statement
• On disposal of revalued asset
• Difference between net book value and net
  disposal proceed to PL account, but loss to the
  extent of increase in revaluation reserve will be
  charged to revaluation reserve account
• Any unsettled amount in revaluation reserve will
  be transferred to general reserve

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Valuation of Fixed Assets in Special Cases

• Hire purchase
• Proportional value to the extent of payment is
  shown in the balance sheet
• Appropriate disclosure regarding HP should be
  made
• Joint ownership with others
• Extent of its share in balance sheet including..,
• Original cost
• Accumulated depreciation
• Written down value
• Can be also grouped with similar fully owned
  assets
• Several assets purchased for a consolidated price
• Consideration is apportioned to the various
  assets on a fair basis as determined by competent
  valuers

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Fixed Assets of Special Types

• Goodwill
• Recorded in books only when some consideration in
  money or moneys worth has been paid for it
• Arises from..,
• Business connections
• Trade name
• Reputation of an enterprise
• Intangible benefits enjoyed by an enterprise
• Goodwill is written off over a period
• Many of them they retain it as an asset without
  writing off

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Disclosure

• Special disclosure required in financial
  statements
• Gross and net book values of FA at the beginning
  and end to show..,
• Additions
• Disposals
• Acquisitions
• Other movements
• Expenditure incurred on account of FA in the
  course of construction or acquisition
• On revaluation of FA, show disclose..,
• Method adopted to compute the revalued amounts
• Nature of any indices used
• Year of any appraisal made
• Whether an external value was involved?

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Stafford Press

• Case 7-3
• Page 213

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Stafford Press

• Founded in 1996
• Founded as one-man job printing firm
• Founded in a small southwestern town
• Owner Lucas Stafford
• Product line concentrated on special line of
  printing
• Experienced rapid growth due to high degree of
  technical proficiency

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Stafford Presss Competitive Disadvantage

• Major market metropolitan area
• Metropolitan area located 300 miles away from the
  plant
• 2006
• Accumulated extra cash to finance a move near the
  primary market
• Expand and modernize facilities at the time of
  move
• Moved to suburb

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Balance Sheet Before the Move to Suburb
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Transaction Arose from the Move

• Land building at old site sold for cash
  149,860
• Accumulated depreciation on building 199,056
  shown in B/S)
• Cost of land 34,034 shown in B/S)
• Cost of building 350,064 shown in B/S)
• Loss on sale of fixed assets 35,182 plug
  figure
• Equipment sold for cash 35,200
• Cost that appeared on book 73,645
• Accumulated depreciation 40,890
• Net book value 32,755
• Gain on sale of fixed assets 2,445 plug
  figure
• Purchased a new printing press
• Invoice cost 112,110
• Cash discount taken 2
• Actually paid 109,868
• Payment to truck delivered 450
• Time spent by Stafford employees on installation
  of the machine 60 hours
• Ordinarily workers received wage at 15 per hour,
  but their time was ordinarily charged to printing
  jobs at 30.50 per hour, the difference
  representing an allowance for overhead (12.15)
  and profits (3.35)

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Transaction Arose from the Move

• Purchased land to build new plant 140,000
• An run down building on the land was torn down
  for 21,235
• Paid for permanent drainage facilities
  installation 13,950
• Purchased a new composing machine
• Invoice cost 28,030 cash paid 20,830,
  Trade-in allowance 7,200
• Could be sold outright for 6,050
• Cost as new machine 12,000
• Accumulated depreciation 5,200
• Net value 6,800

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Transaction Arose from the Move

• Erected building 561,000
• Paid in cash 136,000
• Borrowed on mortgage 425,000
• Trucking / costs associated with moving to new
  location / installation 8,440
• Time spent by Stafford press employees 125 hours

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Transaction Arose from the Move

• During moving a piece of equipment was dropped
  and damaged
• Cost of equipment 10,000
• Amount spent to repair 3,220
• Reduction in salvage value by 660 from 1,950
  to 1,290
• Up until that time, equipment was depreciated at
  850 per year representing a 10 rate after
  deduction of estimated salvage value of 1,950
• Accumulated depreciation 3,220

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Discussion Question

• Analyze the effect of each of these transactions
  on the items in the balance sheet and income
  statement
• For transactions that affect owners equity,
  distinguish between those that affect the net
  income of the current year and those that do not
• Show the appropriate JEs

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Journal Entry (1)
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Journal Entry (2)
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Journal Entry (3)
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Journal Entry (4)
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Journal Entry (5)
In either case trade-in allowance 7,200 is
irrelevant In the second case loss 750 is the
difference between the fair value of trade-in,
6,050, and its 6,800 net book value
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Journal Entry (6)
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Journal Entry (7)
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Journal Entry (8)
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Journal Entry (8)

• However, I dont think an event that changes a
  fixed assets future salvage value is any more
  relevant, in terms of the cost concept, than an
  event that changes its current market value.
  Thus, in my view, rather than adjusting the cost
  of the asset, it is better to amortize the
  reduction in salvage value by adjusting the
  depreciation charge for the rest of the
  equipments useful life, which constitutes a
  change in an estimate. Since the accumulated
  depreciation was 3,220, and annual depreciation
  was 805, the asset was 4 years old, and thus had
  6 years left of useful life. The amount of
  remaining depreciation is the net book value at
  the end of 4 years, 6,780, less the newly
  estimated S1,290 salvage value, or 5,490.
  Divided by 6 years, the new annual depreciation
  expense on this item would be 915. (Easier,
  though not quite as thorough the 660 lesser
  salvage value, spread over 6 years, is 110 per
  year, added to the current depreciation charge of
  805, makes a total of 915.)

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Discussion Question

• Adjust the balance sheet in Exhibit 1 to show the
  effect of these transaction

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Revised Balance Sheet After the Move
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Accounting for Property, Plant, and Equipment and
Other Assets

• Depreciation expense matched with revenues
• Depletion expense matched with revenues in the
  case of natural resources forest land, mineral
  deposits
• Amortized expense matched with revenues in the
  case of intangible assets
• Three phases of accounting for PPE..,
• Determining cost of fixed asset
• Amortizing cost over the useful life of the asset
• Removing it from the accounts at the end of the
  assets life

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Cost of Fixed Assets

• Total amount of expenditures necessary to ready
  the asset for its intended use, which includes..,
• Price of acquiring legal title
• Costs of delivery
• Installation
• Training of employees
• Modification of facilities to use the asset

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Cost of Fixed AssetsExample
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Estimating Depreciation

• Estimate salvage value
• Salvage value expected selling price of the
  asset any removal costs
• Depreciable cost cost salvage value
• Use appropriate depreciation method based on
  following two criteria..,
• Not subject to manipulation by management
  distorting income
• Some resemblance to the decline in value of
  assets measured on historical cost basis

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Straight-Line Depreciation

• An equal portion of depreciable cost is charged
  to some measure of length of an assets life
• Measure may be..,
• Periods of time
• Units of products
• Accumulated depreciation contra asset

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Straight-Line DepreciationExample
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Declining Balance Method

• Principle an asset is most productive in the
  early years of its use
• Charging each period a fixed percentage of the
  original cost of the asset less any previously
  accumulated depreciation

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Long-Lived Fixed Assets

• Physical assets with a life gt 1 year
• Categories
• Plant and equipment depreciation
• Natural resources depletion
• Land appreciation

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Importance of Accounting Numbers Related to
Long-Lived Fixed Assets

• Major determinant of many companies book value
  used in..,
• Equity valuations
• Debt covenants
• Determines companys cost structure and ability
  to improve its capital and employee productivity
• Influences periodic income through depreciation
  and depletion charges
• Improve or depress current profits by lowering or
  raising the level of maintenance expenditures
  required to maintain FAs

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GAAP Depreciation Methods

• Production (Use) method
• Straight-line depreciation
• Used by majority of firms
• Accelerated depreciation
• Mostly confined to tax reporting