Continued from the previous section.pptx

Continued from the previous section

1. Allocating costs of long-lived assets: Fixed assets = Depreciation expense Intangibles = Amortization expense Mineral resources = Depletion expense Depreciatio n is 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. DEPRECIATION—METHOD OF COST ALLOCATION

2. Factors Involved in the Depreciation Process Three basic questions: What depreciable base is to be used? The cost of an asset which is subject to depreciation. What is the asset’s useful life? Service life often differs from physical life. Companies retire assets for two reasons: Physical factors (casualty or expiration of physical life). Economic factors ( inadequacy , supersession , and obsolescence ). What method of cost apportionment is best? DEPRECIATION—COST ALLOCATION

3. The profession requires the method employed be “systematic and rational.” Methods used include: Methods of Depreciation DEPRECIATION—COST ALLOCATION Activity method (units of use or production). Straight-line method. Diminishing (accelerated)-charge methods: Sum-of-the-years’-digits. Declining-balance method.

4. This method is based on the assumption that depreciation is mainly the result of use and that the passage of time plays no role in the depreciation process. Illustration: If Stanley uses the crane for 4,000 hours the first year, the depreciation charge is: Data for Stanley Coal Mines Activity (Unit of production) Method of Depreciation ILLUSTRATION 11-2 Data Used to Illustrate Depreciation Methods ILLUSTRATION 11-3 Depreciation Calculation, Activity Method—Crane Example

5. Under this method, the depreciable cost of the asset is spread evenly (uniformly) over the useful life of an asset. The straight-line method is based on the assumption that depreciation depends only on the passage of time. The depreciation expense for each period is computed by dividing the depreciable cost by the asset’s estimated useful life. The depreciation expense to be reported is the same in each year. Illustration: Stanley computes depreciation as follows: ILLUSTRATION 11-4 Depreciation Calculation, Straight-Line Method—Crane Example Straight-Line Method of Depreciation

6. This method of depreciation results in relatively large amount of depreciation in the early years of an assets life and smaller amounts in later years. This method is based on the assumption of the passage of time. Since most kinds of plant assets are most efficient when new, and so they provide more and better service in the early years of useful life. It is consistent with the matching rule to allocate more depreciation to the early years than to later years if the benefits or services received in the early years are greater. Diminishing-Charge Methods

7. ILLUSTRATION 11-6 Sum-of-the-Years’-Digits Depreciation Schedule— Crane Example A. Sum-of-the-Years’-Digits Each fraction uses the sum of the years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator is the number of years of estimated life remaining as of the beginning of the year. Alternate sum-of-the-years’ calculation n(n+1) 2 = 5(5+1) 2 = 15

8. Utilizes a depreciation rate (percentage) that is some multiple of the straight-line method. Does not deduct the salvage value in computing the depreciation base. B. Declining-Balance Method. ILLUSTRATION 11-7 Double-Declining Depreciation Schedule— Crane Example

9. IFRS requires that each part of an item of property, plant, and equipment that is significant to the total cost of the asset must be depreciated separately. Illustration: EuroAsia Airlines purchases an airplane for €100,000,000 on January 1, 2016. The airplane has a useful life of 20 years and a residual value of €0. EuroAsia uses the straight-line method of depreciation for all its airplanes. EuroAsia identifies the following components, amounts, and useful lives. Component Depreciation

10. Computation of depreciation expense for EuroAsia for 2016. Depreciation Expense 8,600,000 Accumulated Depreciation—Airplane 8,600,000 Depreciation journal entry for 2016. Component Depreciation ILLUSTRATION 11-9 Computation of Component Depreciation

11. Illustration—(Four Methods): Maserati Corporation purchased a new machine for its assembly process on August 1, 2015. The cost of this machine was €150,000. The company estimated that the machine would have a salvage value of €24,000 at the end of its service life. Its life is estimated at 5 years and its working hours are estimated at 21,000 hours. Year-end is December 31. Instructions: Compute the depreciation expense under the following methods. (a) Straight-line depreciation. (c) Sum-of-the-years’-digits. (b) Activity method (d) Double-declining balance. Depreciation and Partial Periods

12. Straight-line Method Depreciation and Partial Periods

13. Activity Method (Assume 800 hours used in 2015) Depreciation and Partial Periods

14. Sum-of-the-Years’-Digits Method 5/12 = .416667 7/12 = .583333 Depreciation and Partial Periods

15. Double-Declining Balance Method Depreciation and Partial Periods

16. Questions: What is the journal entry to correct the prior years’ depreciation? Calculate the depreciation expense for 2015. No Entry Required Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a residual value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2015 (year 8), it is determined that the total estimated life should be 15 years with a residual value of $5,000 at the end of that time. Revision of Depreciation Rates

17. Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000 Balance Sheet (Dec. 31, 2014) After 7 years Equipment cost $510,000 Salvage value - 10,000 Depreciable base 500,000 Useful life (original) 10 years Annual depreciation $ 50,000 x 7 years = $350,000 First, establish NBV at date of change in estimate. Revision of Depreciation Rates

18. Net book value $160,000 Salvage value (new) 5,000 Depreciable base 155,000 Useful life remaining 8 years Annual depreciation $ 19,375 Depreciation Expense calculation for 2015. Depreciation Expense 19,375 Accumulated Depreciation 19,375 Journal entry for 2015 Revision of Depreciation Rates After 7 years

19. special depreciation methods Group Depreciation Method:- The term “group” refers to a collection of assets that are similar in nature. The group method is frequently used when the assets are fairly homogeneous and have approximately the same useful lives. Composite Depreciation Method:- The term “composite” refers to collection of assets that are not similar (or dissimilar) in nature. The composite method is used when the assets are heterogeneous and have different lives

20. DISPOSITION OF PROPERTY, PLANT, AND EQUIPMENT A company may retire or dispose plant assets by Discarding as worthless Sale and Exchange Note: Depreciation must be taken up to the date of disposition.

21. Recording Discarding of a Plant Asset If a plant asset is of no further use to the business and cannot be sold or traded, then the plant asset is discarded. If the asset has no book value, (i.e., if it is fully depreciated), the plant asset account is credited for the amount of the original cost of the item being discarded, and the accumulated depreciation account is debited for the amount of the total accumulated depreciation of the item being discarded. In this case neither gain nor loss is realized. On the other hand, if a plant asset has a book value (if not fully depreciated) at the time it is discarded, the business incurs a loss.

22. Illustration - 1 Suppose on July 5, 2020, equipment that was acquired On Jan 10, 2015, at a cost of Br. 11,000, is discarded as worthless. The discarded equipment has a carrying value of Br. 2,000 at the time of disposal. The carrying value is computed as the difference between the cost of asset Br. 11,000 and accumulated depreciation, Br. 9000. A loss equal to the carrying value should be recorded when the equipment is discarded. Solution: The journal entry required to discard the plant asset as of July 5, 2020 is: July 5. Accumulated Depreciation, Equipment ……9,000 Loss on disposal of plant Asset……..………2,000 Equipment ………..........………………..11,000

23. Illustration: Barret Company recorded depreciation on a machine costing Br.18,000 for nine years at the rate of Br. 1,200 per year. If it sells the machine in the middle of the tenth year for Br. 7,000 , Barret records depreciation to the date of sale as: Sale of Plant Assets DISPOSITION OF PP&E Depreciation Expense ( Br. 1,200 x ½) 600 Accumulated Depreciation —Machinery 600

24. Illustration: Barret Company recorded depreciation on a machine costing $18,000 for 9 years at the rate of $1,200 per year. If it sells the machine in the middle of the tenth year for $7,000, Barret records depreciation to the date of sale. Record the entry to record the sale of the asset: Cash 7,000 Accumulated Depreciation —Machinery 11,400 Machinery 18,000 Gain on Disposal of Machinery 400 DISPOSITION OF PP&E

25. Ordinarily accounted for on the basis of: the fair value of the asset given up or the fair value of the asset received, whichever is clearly more evident. Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance . Exchanges of Non-Monetary Assets

26. Meaning of Commercial Substance Exchange has commercial substance if the future cash flows change as a result of the transaction. That is, if the two parties’ economic positions change , the transaction has commercial substance. Exchanges of Non-Monetary Assets ILLUSTRATION 10-10 Accounting for Exchanges

27. Companies recognize a loss immediately whether the exchange has commercial substance or not. Rationale: Companies should not value assets at more than their cash equivalent price; if the loss were deferred, assets would be overstated. Exchanges—Loss Situation Exchanges of Non-Monetary Assets

28. Illustration: Information Processing, Inc. trades its used machine for a new model at Jerrod Business Solutions Inc. The exchange has commercial substance. The used machine has a book value of €8,000 (original cost €12,000 less €4,000 accumulated depreciation) and a fair value of €6,000 . The new model lists for €16,000. Jerrod gives Information Processing a trade-in allowance of €9,000 for the used machine. Information Processing computes the cost of the new asset as follows. Exchanges of Non-Monetary Assets ILLUSTRATION 10-11 Computation of Cost of New Machine

29. Equipment 13,000 Accumulated Depreciation—Equipment 4,000 Loss on Disposal of Equipment 2,000 Equipment 12,000 Cash 7,000 Illustration: Information Processing records this transaction as follows: Loss on Disposal Exchanges of Non-Monetary Assets ILLUSTRATION 10-12 Computation of Loss on Disposal of Used Machine

30. Exchanges—Gain Situation Has Commercial Substance. Company usually records the cost of a non-monetary asset acquired in exchange for another non-monetary asset at the fair value of the asset given up , and immediately recognizes a gain. Exchanges of Non-Monetary Assets

31. Illustration: Interstate Transportation Company exchanged a number of used trucks plus cash for a semi-truck. The used trucks have a combined book value of $42,000 (cost $64,000 less $22,000 accumulated depreciation). Interstate’s purchasing agent, experienced in the secondhand market, indicates that the used trucks have a fair market value of $49,000. In addition to the trucks, Interstate must pay $11,000 cash for the semi-truck. Interstate computes the cost of the semi-truck as follows. Illustration 10-13 Computation of Semi-Truck Cost Exchanges of Non-Monetary Assets

32. Truck (semi) 60,000 Accumulated Depreciation—Trucks 22,000 Trucks (used) 64,000 Gain on Disposal of Trucks 7,000 Cash 11,000 Illustration: Interstate records the exchange transaction as follows: ILLUSTRATION 10-14 Computation of Gain on Disposal of Used Trucks Gain on Disposal Exchanges of Non-Monetary Assets

33. Exchanges—Gain Situation Lacks Commercial Substance. Now assume that Interstate Transportation Company exchange lacks commercial substance. Interstate defers the gain of $7,000 and reduces the basis of the semi-truck. Exchanges of Non-Monetary Assets

34. Trucks (semi) 53,000 Accumulated Depreciation—Trucks 22,000 Trucks (used) 64,000 Cash 11,000 Illustration: Interstate records the exchange transaction as follows: Exchanges of Non-Monetary Assets ILLUSTRATION 10-15 Basis of Semi-Truck— Fair Value vs. Book Value

35. Summary of Gain and Loss Recognition on Exchanges of Non-Monetary Assets ILLUSTRATION 10-16 Exchanges of Non-Monetary Assets Disclosure include nature of the transaction(s), method of accounting for the assets exchanged, and gains or losses recognized on the exchanges.

36. Characteristics Identifiable. Lack physical existence. Not monetary assets. Normally classified as non-current asset. Common types of intangibles: Patent Copyright Franchise or license Trademark or trade name Customer list Goodwill INTANGIBLE ASSET ISSUES Coca-Cola Company ’s (USA) success comes from its secret formula for making Coca-Cola, not its plant facilities.

37. Purchased Intangibles Recorded at cost. Includes all acquisition costs plus expenditures to make the intangible asset ready for its intended use . Typical costs include: Purchase price. Legal fees. Other incidental expenses. Valuation INTANGIBLE ASSET ISSUES

38. Valuation INTANGIBLE ASSET ISSUES Internally Created Intangibles Companies expense all research phase costs and some development phase costs. Certain development costs are capitalized once economic viability criteria are met. IFRS identifies several specific criteria that must be met before development costs are capitalized.

39. Internally Created Intangibles ILLUSTRATION 12-1 Research and Development Stages INTANGIBLE ASSET ISSUES

40. Amortization of Intangibles INTANGIBLE ASSET ISSUES Limited-Life Intangibles Amortize by systematic charge to expense over useful life. Credit asset account or accumulated amortization. Useful life should reflect the periods over which the asset will contribute to cash flows. Amortization should be cost less residual value. Companies must evaluate the limited-life intangibles annually for impairment.

41. Amortization of Intangibles INTANGIBLE ASSET ISSUES Indefinite-Life Intangibles No foreseeable limit on time the asset is expected to provide cash flows. Must test indefinite-life intangibles for impairment at least annually. No amortization.

42. ILLUSTRATION 12-2 Accounting Treatment for Intangibles Amortization of Intangibles INTANGIBLE ASSET ISSUES

43. Assume that Harcott Co. incurs $180,000 in legal costs on January 1, 2015, to successfully defend a patent. The patent’s useful life is 20 years, amortized on a straight-line basis. Harcott records the legal fees and the amortization at the end of 2015 as follows. Patents 180,000 Jan. 1 Cash 180,000 Patent Amortization Expense 9,000 Dec. 31 Patents (or Accumulated Amortization) 9,000 Illustration Patent Amortization Expense = ($180,000 ÷ 20) = $9,000

44. Conceptually, represents the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized. Only recorded when an entire business is purchased. Goodwill is measured as the excess of ... cost of the purchase over the fair value of the identifiable net assets (assets less liabilities) purchased . Internally created goodwill should not be capitalized. Goodwill

45. Illustration: Feng, Inc. decides that it needs a parts division to supplement its existing tractor distributorship. The president of Feng is interested in buying Tractorling Company. The illustration presents the statement of financial position of Tractorling Company. ILLUSTRATION 12-4 RECORDING GOODWILL

46. Illustration: Feng investigates Tractorling’s underlying assets to determine their fair values. Tractorling Company decides to accept Feng’s offer of $400,000. What is the value of the goodwill, if any? ILLUSTRATION 12-5 RECORDING GOODWILL

47. ILLUSTRATION 12-6 Illustration: Determination of Goodwill. RECORDING GOODWILL

48. Property, Plant, and Equipment 205,000 Patents 18,000 Inventory 122,000 Accounts Receivables 35,000 Cash 25,000 Goodwill 50,000 Liabilities 55,000 Cash 400,000 Illustration: Feng records this transaction as follows. RECORDING GOODWILL

49. Goodwill Write-Off Goodwill considered to have an indefinite life . Should not be amortized. Only adjust carrying value when goodwill is impaired. Bargain Purchase Purchase price less than the fair value of net assets acquired. Amount is recorded as a gain by the purchaser. RECORDING GOODWILL

50. Statement of Financial Position Companies should report as a separate item all intangible assets other than goodwill. Reporting is similar to the reporting of property, plant, and equipment. Contra accounts may not normally shown for intangibles. PRESENTATION OF INTANGIBLES

51. Income Statement Companies should report amortization expense and impairment losses and reversals for intangible assets other than goodwill separately in net income (usually in the operating section). Notes to the financial statements should include the amortization expense for each type of asset. PRESENTATION OF INTANGIBLES

52. Presentation of Intangible Assets PRESENTATION OF INTANGIBLES ILLUSTRATION 12-15 Nestlé’s Intangible Asset Disclosures

53. In accounting, impairment describes a permanent reduction in the value of a company's asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, the company would measure and recognize an impairment loss. the loss on the limited-life intangible is reported as part of income from continuing operations. The entry generally appears in the “Other expenses and losses” section. Impairment of intangible assets

54. To illustrate, assume that Ethio , Inc. has a patent on how to extract oil from Dashn rock. Unfortunately, several recent non- Dashn oil discoveries adversely affected the demand for Dashn -oil technology. Thus, the patent has provided little income to date. As a result, Ethio performs a recoverability test. It finds that the expected net future cash flows from this patent are Br.35 million. Ethio’s patent has a carrying amount of Br.60 million. Because the expected future net cash flows of Br.35 million are less than the carrying amount of Br.60 million, Ethio must determine an impairment loss.

55. Discounting the expected net future cash flows at its market rate of interest, Ethio determines the fair value of its patent to be Br.20 million. The impairment loss computation (based on fair value) is Carrying amount of patent Br.60, 000,000 Less : Fair value (20,000,000) Loss on impairment Br.40, 000,000 Ethio records this loss as follows: Loss on Impairment 40,000,000 Patents 40,000,000

56. The impairment test for an indefinite-life asset other than goodwill is a fair value test. This test compares the fair value of the intangible asset with the asset’s carrying amount. If the fair value is less than the carrying amount, the company recognizes impairment. Companies use this one-step test because many indefinite life assets easily meet the recoverability test (because cash flows may extend many years into the future). Thus, companies do not use the recoverability test. R ecoverability test  evaluates if an asset 's undiscounted future cash flows are less than the asset's book value.  Impairment of Indefinite-Life Intangibles Other Than Goodwill

57. To illustrate, assume that Hibr Radio purchased a broadcast license for Br.2, 000,000. The license is renewable every 10 years if the company provides appropriate service and does not violate Ethiopian broadcasting rules. Hibr Radio has renewed the license with the EBC twice, at a minimal cost. Because it expects cash flows to last indefinitely, Hibr reports the license as an indefinite-life intangible asset. Recently, the EBC decided to auction significantly more of these licenses. As a result, Hibr Radio expects reduced cash flows for the remaining two years of its existing license.

58. It performs an impairment test and determines that the fair value of the intangible asset is Br.1, 500,000. Hibr therefore reports an impairment loss of Br.500, 000, computed as follows. Carrying amount of broadcast license Br.2, 000,000 Less : Fair value of broadcast license 1,500,000 Loss on impairment Br. 500,000 Hibr Radio now reports the license at Br.1, 500,000, its fair value.

59. The impairment rule for goodwill is a two-step process. The company compares the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds the carrying amount, goodwill is not impaired. The company does not have to do anything else. if the fair value of the reporting unit is less than the carrying amount of the net assets, then the reporting unit would perform a second step to determine possible impairment. In the second step, the reporting unit determines the fair value of the goodwill (implied value of goodwill) and compares it to its carrying amount. Impairment of Goodwill

60. Example: assume that the fair value of the Selam co. is Br.1, 900,000 & the book value was Br 2,400,000 including goodwill of Br. 900,000. Fair value of Selam co. Br.1, 900,000 Less : Net identifiable assets (excluding goodwill) (Br.2, 400,000 - Br.900, 000) 1,500,000 Implied value of goodwill Br. 400,000

61. It not in themselves intangible assets. However these activities frequently result in the development of patents or copyrights (such as a new product, process, idea, formula, composition, or literary work) that may provide future value. Research Activities: Planned search or critical investigation aimed at discovery of new knowledge. Development Activities : Translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. Research and development (R&D) costs

62. Two difficulties arise in accounting for R&D expenditures: Identifying the costs associated with particular activities, projects, or achievements, and determining the magnitude of the future benefits and length of time over which such benefits may be realized. Charge all research cost to expense. [IAS 38.54] Development costs are capitalised only after technical and commercial feasibility of the asset for sale or use have been established. This means that the enterprise must intend and be able to complete the intangible asset and either use it or sell it and be able to demonstrate how the asset will generate future economic benefits. [IAS 38.57]

63. Presentation of Research and Development Costs PRESENTATION OF INTANGIBLES Companies should disclose the total R&D costs charged to expense each period. ILLUSTRATION 12-16 R&D Reporting

64. Natural resources can be divided into two categories: Biological assets (timberlands) Fair value approach Mineral resources (oil, gas, and mineral mining). Complete removal (consumption) of the asset. Replacement of the asset only by an act of nature. Depletion - process of allocating the cost of mineral resources. Natural resources

65. Establishing a Depletion Base Computation of the depletion base involves: Pre-exploratory costs. Exploratory and evaluation costs. Development costs. DEPLETION

66. Write-off of Resource Cost Normally, companies compute depletion on a units-of-production method (activity approach). Depletion is a function of the number of units extracted during the period. Calculation: Total Cost – Residual value Total Estimated Units Available = Depletion Cost Per Unit Units Extracted x Cost Per Unit = Depletion DEPLETION

67. Illustration: MaClede Co. acquired the right to use 1,000 acres of land in South Africa to mine for silver. The lease cost is €50,000, and the related exploration costs on the property are €100,000. Intangible development costs incurred in opening the mine are €850,000. MaClede estimates that the mine will provide approximately 100,000 ounces of gold. DEPLETION ILLUSTRATION 11-19 Computation of Depletion Rate

68. If MaClede extracts 25,000 ounces in the first year, then the depletion for the year is €250,000 (25,000 ounces x €10). Inventory 250,000 Accumulated Depletion 250,000 MaClede’s statement of financial position: Depletion cost related to inventory sold is part of cost of goods sold. DEPLETION ILLUSTRATION 11-20 Statement of Financial Position Presentation of Mineral Resource

69. Presentation on the Financial Statements Disclosures related to E&E expenditures should include: Accounting policies for exploration and evaluation expenditures, including the recognition of E&E assets. Amounts of assets, liabilities, income and expense, and operating cash flow arising from the exploration for and evaluation of mineral resources. DEPLETION

70. Presentation of Property, Plant, Equipment, and Mineral Resources Basis of valuation (usually cost) Pledges, liens, and other commitments Depreciating assets, use Accumulated Depreciation. Depleting assets may include use of Accumulated Depletion account, or the direct reduction of asset. Disclosures PRESENTATION AND ANALYSIS