CH 10 and 11 Flashcards
- When we incur costs related to property and equipment, what are the two choices of treatment?
Capitalize (include them in cost of the asset to be depreciated) or expense (consider a current period expense which lowers net income in the current period).
- How do we treat interest incurred on construction loans?
If it is “avoidable” interest (we would not have incurred this interest if we hadn’t had the construction loan), we capitalize that interest into the cost of the asset under construction.
- What criteria do we use to determine if a cost should be capitalized into the cost of a fixed asset?
Is the amount material? (if not material, expense)
Does this cost change the original use of the asset or prolong its life? (if no, then expense)
Is this a one-time cost or is it recurring? (if recurring, then expense)
- When do we begin to depreciate a fixed asset?
When it is placed in service.
- How do we determine gain/loss on exchange of an asset for another asset?
Compare the net book value (cost – accumulated depreciation) with the fair market value (or fair value) of the asset. If FV is higher, then gain – if lower, then loss.
- When is an asset exchange said to have “economic substance?”
If cash flows resulting from the exchanged asset are substantially different from those of the original asset (usually when different types of assets involved – e.g. vehicle exchanged for land).
- What is the proper treatment of gains on exchange of assets?
If exchange has economic substance, then recognize gain.
If exchange lacks economic substance, if no cash received, defer all of gain (reduce carrying value of the new asset by the gain).
If the exchange lacks economic substance and some cash is received and if cash is less than 25% of total value of assets received (cash plus FV of new asset), then recognize the % of the cash to the total received times the gain. The balance of the gain is deferred
- If a car is totaled in an accident, how do we treat the insurance payment that we receive for the car?
We treat the proceeds as if we had sold the car for the amount of the proceeds and calculate/recognize gain or loss upon disposal of the car.
- What is the entry need to record the retirement of an asset?
A/D XXX
Loss on retirement of asset XXX (equal to net book value of asset)
Asset
What is salvage value and how does it affect calculation of depreciation?
It is the expected value of the asset at the end of its useful life. We subtract SV from cost to arrive at depreciable cost which is used in calculating depreciation expense in all methods except DDB.
How do we determine the annual depreciation using the DDB method?
Multiply cost (ignore SV) by a fraction – numerator is 2 (because it is DOUBLE declining balance) and denominator is estimated useful life.
Then, resulting NBV becomes depreciable basis for next year. We use the same fraction each year, but the depreciable basis declines each year as NBV gets lower and lower.
An asset is said to have a 7-year useful life. Using SYD, determine the fraction used to calculate annual depreciation in year 3.
7+6+5+4+3+2+1 = 28 is denominator and 5 is numerator since 5 is the number of years left in the life of the asset (including that year) in year 3. So, 5/28 X depreciable cost of asset.
