Chapter 7

Question 1

What are two types of long live assets and what does long live asset mean?

Answer 1

Plant assets and intangible assets

Long-lived assets are expected to be used for more than one year.

Question 2

What are plant assets?

Answer 2

Plant asset are tangible; you can touch them. Common plant assets are land, buildings, equipment, furniture, and vehicles.

Question 3

What are intangible assets?

Answer 3

Intangible assets represent special rights or legal benefits. Include land, buildings and equipment. They do not have physical substance; you can’t touch them. Common intangibles are patents, copyrights and trademarks.

Question 4

Name which types of plant assets are not effected, depreciated, depleted, and amortized.

Answer 4

None : LAND

Depreciated: Buildings & Equipment, Furnitures & Fixtures, Land Improvements

(basically all plant assets except land are depreciated)

Depleted: Natural Resources

Trick question: ONLY INTANGIBLES ARE Amortized

Question 5

Plant Assets and Intangibles are listed under what?

And the results (Depreciation, amortization, depletion) show up where?

Answer 5

This table shows common accounts within plant assets. The assets appear on the balance sheet, usually in their own section.

While the results are an expense on the income statements.

Question 6

What is the cost of a plant asset?

Answer 6

Sum of all the costs incurred to bring the asset to its intended use

so it’s not just the building, i’s the repairs & renovations. It’s not just land improvements, it’s security systems, lighting, paving. It’s not just machinery & equipment, it’s insurance in transit, installation.

Question 7

What is a lump-sum purchase and how is the cost allocated?

Answer 7

Companies purchase several assets in a group for one price. So land, building and land improvements could just be one set price and all purchased together.

For accounting purposes, the assets must be separated into the appropriate accounts. The purchase price is allocated based on the fair values of the individual assets.

Question 8

What is a capital expenditure and some examples?

Answer 8

Increase capacity or extend life

Examples:
Major overhaul
Building additions

Should be capitalized

Question 9

How do companies decide if the cost is a capital expenditure that becomes part of the cost of the asset or if it is an expense? And what helps make their decision?

Answer 9

If the cost increases the capacity or extends the life of the asset, it should be capitalized. If the cost is just to maintain normal working order of the asset, it should be expensed.

Companies often set a dollar amount, say $1000, to help make this decision. If it is under the dollar amount, the item is expensed. If it is above, it is capitalized.

Question 10

What is an immediate expense and some examples?

Answer 10

Maintain or restore to working order

Examples:
Minor repairs
Painting

Should be expensed

Question 11

What does depreciation mean ? Why does depreciation happen and what is the allocation of a cost?

Answer 11

The expense to record the “using up” of plant assets is called depreciation.

Plant assets wear out or grow obsolete over time

The cost of a plant asset is allocated to an expense over its life

Question 12

What are three things that Depreciation absolutely does not mean?

Answer 12

It’s important to remember that depreciation is not a process of valuation. It does not correspond to the decrease in market value that occurs. It also does not set aside funds to purchase new plant assets.

Question 13

How do you measure depreciation? And what is the formula?

Answer 13

Cost of the plant asset
Estimated Useful Life
Estimated Residual Value

Depreciable Cost = Asset’s cost - Estimated Residual Value

Question 14

What does estimated useful life mean?

Answer 14

How long the company expects to use the asset

The company must estimate a useful life for the asset. This is based on how long the company expects to use the asset in the business.

Question 15

What does Estimated residual value?

Answer 15

A residual value must also be estimated. This is the expected cash value of the asset and the end of its useful life. Some companies assign a residual value of zero.

Question 16

What is the cost of the plant asset?

Answer 16

The cost of the plant asset that includes the purchase price, plus all the other necessary costs to get the asset ready for use.

Question 17

What are the three most common methods of depreciation ?

Answer 17

Straight-line (S/L)
Units-of-production (UOP)
Double-declining-balance (DDB)

Question 18

What is important to remember about the entry to record depreciation ?

Answer 18

Remember, the entry to record depreciation is the same regardless of the method.

Depreciation expense is debited and will appear on the income statement.

Accumulated depreciation, a contra-asset, is credited and will appear on the balance sheet. It will be deducted from the cost of the plant asset to determine its book value.

Question 19

What is the formula for Straight Line Depreciation?

Answer 19

Depreciable Cost - Residual / Useful Life in years

Question 20

What is the impact of depreciation each year?

What does accumulated depreciation mean?

Answer 20

Accumulated Depreciation increases
Book value decreases

The word “accumulated” means that this account will grow each year as depreciation is added to it over the life of the plant asset. Since accumulated depreciation is subtracted from the cost of the asset, as it increases, the book value decreases.

Question 21

What is the impact of depreciation at the end of the asset’s life?

Answer 21

At the end of the asset’s useful life, the book value will equal its residual.

Question 22

What is Units-of-Production?

How is it measured?

What does this method result in?

Answer 22

Depreciation per unit is computed. the life is expressed in units, not years.

Units can be measured in any input or output of an asset.

This method results in varying amounts of depreciation each period, depending on the use of the asset.

Question 23

What is the formula for Units of Production?

Answer 23

Cost - Residual / Useful Life, in units = Depreciation expense per unit

and

Depreciation Expense Per Unit x Units produced during the period

Question 24

What is the double-declining balance and what does it mean?

Answer 24

Double-declining-balance is an accelerated method. This means that early in the asset’s life, large depreciation amounts are expensed. Later in the life of the asset, the amounts are smaller.

Question 25

Describe what the steps for Double-Declining Balance formula is?

Answer 25

DDB = (2/Useful life)
Book Value = (Cost-Accumulated Depreciation)
Then DDB x Book Value

First, the DDB rate is computed. This is found by dividing two by the useful life. This is often referred to as twice-the-straight-line rate. It usually expressed as a percent. The DDB rate is multiplied by the book value of the asset (not cost minus residual).

Question 26

What happens in the first year and each year regarding accumulated/book values?

What is important to know about DDB?

Answer 26

In the first year, the book value will equal the asset’s cost. However, each year as accumulated increases, book value decreases, and thus, so does depreciation expense.

You need to be careful with this method not to depreciate below residual. The formula is not set up to “stop” when depreciable cost equals residual value. In the last year, or earlier in some cases, the depreciation expense is “forced” so that ending book value equals residual.

Question 27

What is a Modified Accelerated Cost Recovery System and why was it invented?

Answer 27

The IRS, to encourage investment in long-term assets, developed a special accelerated depreciation method abbreviated MACRS. It is similar to the DDB method. This allows greater tax deductions early in assets’ lives and reduces taxable income. Therefore, cash that would have been used to pay taxes can now be used for other purposes.

Question 28

Which method do most companies use and why?

Answer 28

Most companies use straight-line depreciation for external reporting. It provides an equal amount each year.

Question 29

What is a Partial Year Depreciation computation and why does it exist?

What does it not apply to?

Answer 29

Companies don’t usually purchase all their plant asset on January 1.

1. Compute depreciation for a full year
2. Multiply by fraction of the year the asset is owned

To compute depreciation for a partial year, determine depreciation for a full year and then multiply by a fraction–the numerator is the number of months the asset was used during the year (purchase date to end of year); the numerator is 12 for the months in a year. This does not apply to UOP because the life is not expressed in years, but in units.

Question 30

Why would a company change useful life of asset?
What is this called?
What’s the formula?
And what does it mean?

Answer 30

A company may change useful based on new information or experience

Called a change in estimate

Depreciation formula needs to be revised
Book value at time of change / Remaining Useful Life

The book value at the time of the change is computed (cost less accumulated deprecation up to the date of the change) is divided by the remaining useful life (from that day forward).

Question 31

What happens when a company is finished using an asset?

Answer 31

The asset can be discarded, sold, or exchanged

Question 32

What happens before accounting for the disposal of an asset?

Answer 32

Depreciation must be updated and a final book value is determined.

Question 33

Describe the discarding of a Plant Asset.

Answer 33

Accumulated depreciation and cost of asset removed from records

Loss recorded (unless asset is fully depreciated and no residual value)

Question 34

More in-depth explanation of discarding plant asset

Answer 34

If a company discards an asset (throws away and receives nothing), it will incur a loss. The only exception to this would be if the asset was fully depreciated and had a residual value of zero. The plant asset account and its related accumulated depreciation must be removed from the records, because the company no longer has the asset. Accumulated is debited for its balance and the plant asset account is credited for its cost. A loss is debited for the difference, which in this case, will equal the asset’s book value. The loss is an income statement account that will reduce net income.

Question 35

What happens when an asset is sold for cash?

Answer 35

When an asset is sold for cash, the company can incur a gain or a loss.

Question 36

What happens if you sell an asset and the cash received is lesser than the book value? What is it similar to? How is it recorded and what does it affect?

Answer 36

If the cash received is less than the book value, then a loss is recorded. A loss is similar to an expense.

It is reported on the income statement and decreases the net income

Question 37

What happens if you sell an asset and the cash received is greater than the book value? What is it similar to? How is it recorded and what does it affect?

Answer 37

If the cash received for the asset is greater than the book value, a gain will be recorded. A gain is similar to a revenue.

It is reported on the income statement and increases net income.

Question 38

What are natural resources?

What is the process of allocating the cost of a natural resource to an expense?

Answer 38

Natural resources are extracted from the land—for example, oil, coal, timber and mineral ore.

It is called depletion.

Question 39

What does depletion record?

What is the method to compute? **Missing Formula

Answer 39

Depletion records the expense related to extracting the natural resource

**Formula

Question 40

What are intangible assets?

Answer 40

Represent special rights and benefits

Have no physical form

Very valuable in today’s information-driven society
Examples include patents, copyrights, customer lists

Question 41

What are the two categories of intangibles?

Answer 41

Finite lives and Indefinite lives

Question 42

What are finite lives?

Can it be measured?

What method is used?

How is it reduced?

Answer 42

A category of intangible.

Finite lives that can be measured.

Amortized using the straight-line method

Intangible asset is reduced by amortization.

No Accumulated Amortization account

Question 43

What are indefinite lives? What are 2 facts.

Answer 43

A category of Intangibles.

Not amortized

Tested annually for loss in value

Question 44

In-depth explanation of Intangibles.

Answer 44

Intangibles are placed into two categories based on their lives. Those intangibles that have lives that can be measured are amortized.= Amortization is like depreciation; it allocates the cost of the intangible over its life–usually using the straight-line method. One difference from depreciation, however, is that there is no “accumulated amortization” account. Instead, the asset is reduced directly.
The other category of intangibles is those with indefinite lives. These assets are not amortized. Instead, they are tested annually for any loss in value.

Question 45

What is amortization?

Answer 45

Amortization is like depreciation; it allocates the cost of the intangible over its life–usually using the straight-line method.

Question 46

What are four types of specific intangibles?

Answer 46

Patents

Copyrights

Trademarks & Trade Marks

Franchises and Licenses

Question 47

What are patents?

Answer 47

Federal grants that give holder exclusive right to produce and sell an invention for 20 years

Question 48

What are copyrights?

Answer 48

Exclusive right to sell a book, music, file or other work of art; lasts for the life of the author + 70 years

Question 49

What are Trademarks and Trade Names?

Answer 49

Distinctive identification of
product or service; a logo
or catch phrase

Question 50

What are Franchises & licenses?

Answer 50

Right to sell a product or service with specific Conditions, such as chain restaurants

Question 51

In-depth explanation about specific intangibles

Answer 51

Here, we describe some common intangibles. Patents are purchased from the federal government and grant the exclusive right to produce and sell an invention for 20 years. Often companies assign a shorter life because other companies “infringe” upon the patent. It usually takes litigation to solve this issue. Copyrights are the exclusive right to a literary or artistic work. The original copyright is purchased from the government, but then the holder can sell to others. The life of a patent is the author’s life plus 70 years. Unique symbols or sayings that identify a company’s product or service are trademarks and trade names. Think of the brand name Coca-Cola or the Nike “swoosh”. Franchises give the owner the right to sell a product or service with specific conditions. The holder pays the corporation a fee to use the business name and sell its product and services. Many chain restaurants, like Burger King, are set up in this manner.

Question 52

What does the term goodwill mean?

Answer 52

It is an asset that is only recorded when an entire business is purchased

Purchase price exceeds fair value of net assets of business

Represents earning power of purchased business

Not amortized

Question 53

In-depth explanation of good-will

Answer 53

Goodwill is a term used in many different ways. In accounting, the meaning is very specific. A company can only record goodwill as an intangible asset if it purchasing another company, and the purchase price is greater than the fair value of the company’s net assets. Theoretically, if a company is willing to buy another company for more than its worth, it must represent superior earnings power that the acquired company holds. Goodwill is an example of an asset that has an indefinite life, and therefore, it is not amortized.

pay more for the company than the value of the asset- the in between is the goodwill

Question 54

What are research and development costs? How is it recorded and why?

Answer 54

Not an intangible asset

Required to be expensed as incurred

Since many of these projects are unsuccessful, they are required to be recorded as an expense. Expenses suck cause it lowers net income.

Question 55

What two sections can plant asset transactions appear on a Cash Flow Statement?

Answer 55

In the operating section and investing section

Question 56

What is the operating section? And what goes there?

Think plant assets

Answer 56

It is a part of the Cash Flow statement.

In the operating section, depreciation, amortization and depletion expense are added back to net income. These are non-cash expenses and, when added to net income, help determine cash provided by operating activities.

Question 57

What is the investing section? And what goes there? (Think Plant Assets)

Answer 57

It is a part of the Cash Flow statement.

Purchases and sales of plant assets appear in the investing section. If plant assets are purchased with cash, it is shown as an investing outflow. The cash proceeds received from selling plant asset is shown as an inflow.