MIDTERMS Flashcards
Define depreciation.
The decrease in the value of physical property with the passage of time.
The accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
Define value.
The present worth of all future profits that are to be received through ownership of a particular property.
Define market value of a property.
The amount which a willing buyer will pay to a willing seller for the property where each has equal advantage and is under no compulsion to buy or sell.
Define fair value of a property.
The value which is usually determined by a disinterested party in order to establish a price that is fair to both seller and buyer.
Define utility or use value of a property.
What the property is worth to the owner as an operating unit.
Define book value/depreciated book value.
The worth of a property after being deducted by the accumulated depreciation.
Define salvage or resale value.
The price that can be obtained from the sale of the property after it has been used.
Define scrap value.
The amount the property would sell for if disposed off as a junk.
2 reasons why we need to consider depreciation
- To provide for the recovery of capital which has been invested in physical property.
- To enable the cost of depreciation to be charged to the cost of producing products or services that results from the use of the property.
5 differences between market value and book value.
- MV depends on how much the market is willing to pay for it, BV is determined based on depreciation.
- MV may increase or decrease, BV will always decrease.
- MV is applicable to any type of property, BV is not applicable for land, gold, etc.
- MV is considered for valuation, BV is considered for account books in company.
- MV depends on supply, demand, development of area, etc., BV depends only on the passage of time and is not dependent on demand and supply.
Describe depreciation as business expense.
Depreciation is viewed as part of business expenses that reduce taxable income.
Illustrate asset depreciation concept. (Flow Diagram)
Depreciation
- Economic Depreciation - the gradual decrease in utility in an asset with use and time.
a. Physical Depreciation -due to lessening physical ability of a property to produce results (wear and tear)
b Functional Depreciation - due to the lessening of demand for the function the property was designed to render (obsolescence) - Accounting Depreciation - the systematic allocation of an asset’s value in position over its depreciable life.
a. Book Depreciation - used by corporation or business for internal financial accounting to track the value of an asset or property over its life.
b. Tax Depreciation - used by corporation or business to determine taxes due based on current tax laws of the government entity (country, state, province, etc.)
Gross Income - Expenses:
(Cost of goods sold)
(Depreciation)
(Operating Expenses)
____________________
Taxable Income
- Income Taxes
____________________
Net Income (Profit)
4 Factors to consider in Asset Depreciation
- Depreciable Life (how long?)
a. Physical life of a property - The length of time during which it is capable for performing the function for which it was designed and manufactured.
b. Economic Life - The length of time during which the property may be operated at a profit. - Salvage Value (disposal value)
- Cost Basis (depreciation basis)
- Method of Depreciation (how?)
Define depreciable property and give examples.
Depreciable property is property for which depreciation is allowed under federal, state, or municipal income tax laws and regulations.
Example: buildings, motor vehicles, equipment
A property is depreciable if:
- It must be used in business or held to produce income.
- It must have a determinable useful life, and the life must be longer than one year.
- It must be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes.
- It is not inventory, stock in trade, or investment property.
2 Types of Depreciable Properties
- Tangible Property - can be seen, touch, and felt.
a. Real - anything that is erected on (ex. buildings), growing on, (trees), or attached to land
b. Personal - equipment, furnishings, vehicles, office machinery, or not defined as real property
- Intangible Property - has value but cannot be seen or touched. Examples: patents, copyrights, and trade marks
a. Goodwill - That element of value which a business has earned through favorable consideration and patronage of its customers arising from its well-known and well conducted policies and operations.
b. Franchise - an intangible item of value arising from the exclusive right of a company to provide a specific product or service in a stated region of the country.
c. Going Value
- an intangible value which an actually operating concern has due to its operation.
d. Organization cost
- the amount of money spent in organizing a business and arranging for its financing and building.
6 Depreciation Methods
- Straight-Line Method
- Sinking Fund Method
- Declining Balance Method
- Double Declining Balance Method
- Sum of the Years’ Digits (SYD) Method
- Service Output Method
Discuss the Principle of Straight-Line Method.
- A fixed asset is providing its service in a uniform fashion over its life.
- Assumes that the loss in value is directly proportional to the age of the property.
Discuss the Principle of Sinking Fund Method.
- a technique for depreciating an asset while generating enough money to replace it at the end of its useful life.
- assumes that a sinking fund is established in which funds will accumulate for replacement
- these funds sit in a sinking fund account and generate interest
- the total depreciation that has taken place up to any given time is assumed to be equal to the accumulated amount in the sinking fund at that time.
Discuss the Principle of Declining Balance Method.
• sometimes called the constant percentage method or the Matheson Formula
• it is assumed that the annual cost of depreciation is a fixed percentage of the salvage value at the beginning of the year
• a fixed asset as providing its service in a decreasing fashion
• this method does not apply if the salvage value (CL) is zero because k will be equal to 1 and d1 will be equal to C0
Discuss Double Declining Balance Method.
• very similar to the Declining Balance Method except that the rate of depreciation, k, is replaced by 2/L
• a fixed asset as providing its service in a decreasing fashion
Discuss Sum of the Years’ Digits (SYD) Method
• Depreciation concept similar to DB but with decreasing depreciation rate
• Charges a larger fraction of the cost as an expense of the early years than of the later years
Discuss Service Output Method
• assumes that the total depreciation that has taken place is directly proportional to the quantity of output of the property up to that time.
• has the advantage of making the unit cost of depreciation constant and giving low depreciation expense during periods of low production
Differentiate Equity vs Borrowed Capital
Equity Capital
* Supplied and used by the owner of an enterprise in the expectation that profit will be earned.
Borrowed Funds
* Supplied by others on which a fixed rate of interest must be paid, and debt must be repaid at specified time.
Defined Bond.
- Certificate of indebtedness of a corporation (<10years), and guaranteed by a mortgage or certain assets of the corporation or its subsidiaries.
- Issued when there’s a need of more capital
Define Face/Par Value
• Amount stated on the bond
• When it is repaid = bond is retired/redeemed
Define Bond Rate
Interest rate quoted on the bond
2 Methods of Bond Retirement
- Issue another set of bonds equal to the amount of bonds due for redemption.
- Set-up sinking fund which periodic deposit of equal amount are made (annuity). Accumulated amount of sinking fund is equal to amount needed to retire the bond at the time rate they are due.
(*See formula in pdf)
Define Bond Value and give its formula.
Value of a bond is the present worth of all future amounts that are expected to be received through ownership of the bond.
Formula: (see pdf)
Define Fixed Cost.
costs which remain constant, whether or not a given change in operation or policy is adopted.
Define Increment Cost or Variable Cost
Arise as the result of a change in operation or policy.
Define Marginal Cost
Additional cost of producing one or more unit of a product.
Define Sunk Cost and give its formula.
Money which has been spent or capital which has been invested that cannot be recovered due to certain reason.
Formula: Sunk Cost = Book Value (Cn) – Resale Value
Breakeven Analysis
It is performed to determine the value of a variable or parameter of a project or alternative that makes two elements equal, for example, the sales volume that will equate revenues and costs.
Breakeven point
It is the value of a key factor at which we are indifferent between two alternatives.
