Long Term Assets are assets that have a useful life of more than 1 year and are used in the operation of the business (not for investments or for sale to customer). They may be tangible or intangible.
Assets that are for sale to customer are classified as inventory.
Financing
Long-term assets are generally financed for the term of the life of the asset.
If you don't do that, problems can arise, such as the Savings and Loan Crisis of the 1980s.
S&Ls were once limited in their investments. They would invest in local mortgages. In 1980, they were deregulated and they could invest anywhere and in any thing. The mortgages were their assets. The deposits (savings accts and CDs) were their liabilities. CDs typically have short term maturity (less than 5 years). Short term interest went up and the mortgage rates were constant and low. Investors continued to invest in CDs because they were insured by the FDIC. The Resolution Trust Corporation bailed them out.
Accounting for Acquisiton of Long-Term Assets
All costs incurred in the purchase of the asset and preparing it for use are included in the cost. Such as tariffs, cost to tear-down an existing building, legal fees, commissions, delivery charges
Depreciation
Depreciation is used to record wear and tear on the long-term assets over time.
Debit Depreciation Expense
--- Credit Accumulated Depreciation - Equipment
Impairment
You mark down an asset to its fair market value from its carrying value if the fair market value is lower. Carry value = cost-accumulated depreciation. Only write down the value of the asset if the carry value exceeds the undiscounted projected cash flows.
Example: Quaker Oats bought Snapple. But Snapple didn't produce. Nonetheless, the value of Snapple was still higher than its carry value.
This last rule does not conform to internation accounting standards and may be subject to change in the future.
Depreciation
In order to calculate depreciation, you must know
- original cost
- residual value
- useful life
Straight Line Depreciation
In this method:
Depreciation Expense per Year = (1/useful life) x (cost - salvage)
See SE5 page 497
Partial year depreciation is prorated. Note: This type of question (where you have partial year depreciation) is on the final. So, be prepared!
Unit of Production Depreciation
Not used very much, but it's related to depletion.
Amount of depreciation should be relative to the utilization of the asset. Rather than # of years, use this year's activity.
Depreciation expense for Year = (this year's activity/estimated total activity) x (cost - residual value)
See SE6 page 498
After the asset reaches the residual/salvage value, you stop depreciating and leave it on the books at the residual/salvage value.
Double Declining Balance Depreciation
This is primarily used for tax accounting. The idea is that the depreciation is twice the normal depreciation, but use accumulated depreciation instead of salvage value.
Depreciation expense for the year = 2 x (1/useful life) x (cost - accumulated depreciation)
See SE7 page 498
Repairs and Improvements
Normal repairs are expensed.
Debit Repairs Expense
--- Credit Cash
But if the repairs actually extend the useful life of the asset, it's an extraordinary repair and you record it in a way to increase the carry value of the asset.
Debit Accumulated Depreciation
--- Credit Cash
If you literally add on to the asset or make it significantly better, you increase the value of the asset
Debit Asset
--- Credit Cash
Abandonment of an Asset
When you walk away from an asset, you record the abandonment of the asset:
Debit Loss on Abandonment (and expense account)
Debit Accumulated Depreciation (to get that off the books)
--- Credit Asset (to get that off the books)
Sale of an Asset
Depreciate for part of the year
Debit the Loss on Sale or Credit the Gain on Sale
Land
Land is not depreciated. But if you pave it as a parking lot, you would depreciate the pavement cost. If the land comes with a building, separate them out and depreciate the building, but not the land.
Natural Resources
If you buy land for it's minerals or other resources, you depreciate those resources with "depletion".
Depletion expense for the year = (this year's activity/estimated total activity) x (cost - residual value)
This is similar to the unit of production method above.
Intangible Assets
These are assets that are used in the business and have a useful life, but are intangible. Accounting rules changed recently and it was decided that intangible assets should be amortized over time. This is similar to depreciation with tangible assets. Always use straight line method with amortization.
If it has an unlimited useful life, review it at the end of each year for impairment. If it has been impaired, write it down.
Examples: patent, copyright, leasehold, leasehold improvement, trademark, franchise, goodwill, r&d, computer software costs
Patent gives you an exclusive right to sell. US patents do not apply to Europe. If you manufacture in Africa, you don't need a patent unless you will sell there.
Leasehold is the acquisition of the remaining terms of an existing lease, i.e a sublease.
A leasehold improvement is when you improve any property that you lease, either regular or sub lease. Ex: new carpeting or a building on leased property. It's intangible because you don't end up owning these improvements, only the right to use them for the duration of the lease.
Franchise goes on the franchisee's books.
Goodwill
Excess of what you paid over the fair market value of what you acquire in a business transaction.
Record this as:
Debit Assets (at Fair Market Value)
Debit Goodwill
--- Credit Cash
Historically, goodwill was amortized over a period of not more than 40 years. That's the old rule. Around 1999/2000, FASB changed and decided that it must by tested for impairment each year and written down if there is an impairment.
Classic case was Time Warner when they acquired AOL. They paid much more than the FMV of the underlying value - about $120b. When the rule changed and they had to check for impairment, they had to write down $90b. The largest quarterly loss in history.
At about the same time, Enron restated their financial statements by about $80m-$1b. Enron went bankrupt, but AOL/TW stayed in business. How is that possible? It's because people lost trust in Enron, whereas AOL/TW was just a mistake.
Research & Development
R and D is expensed
Computer Software Costs
These costs are also expensed except when you're developing the software for sale. From the point that you determine that there is a market for it, you can capitalize the costs.
US Income Tax Depreciation Rules
This is called modified accelerated cost reduction (MACRS). It's based on tables which are based on the computations that we made earlier - straight-line, unit of production, etc. Real property (fixed in place) is generally straight line. Personal (moveable) property uses declining balance.
No comments:
Post a Comment