Week 3 Purchasing and Financing Business Assets
3.1 Accounting for Tangible Long-Term Assets
3.1.1 Defining an Asset
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Utilizing ASPE this course
Asset: an “economic resource controlled by an entity as a result of past transactions or events
and from which future economic benefits may be obtained”
o An asset is a resource, controlled by a company that will help the company obtain
future economic benefits (rev or cash flows)
ASPE Criteria to Record an Asset
o 1. It represents a future benefit that contributes directly/indirectly to future net cash
flows
 The shop is the location where customers purchase coffee in the future.
Customers pay the coffee shop, contributing to cash flows
o 2. The company can control access to the benefit
 Purchasing the shop gives owners control access to the benefit. They can set
store hours and operating hours.
o 3. The transaction or event which provides the company with control of the benefit has
already occurred.
 The transaction has already occurred
Current Assets: economic resources that will be sold or used by a company within 12 months of
the reporting period
o e,g if preparing financial statements as at Mar 31, current assets will be those that are
sold or used before March 31 of the following year.
Long-Term Assets: economic resources that will be used by a company to generate income over
multiple years
Tangible Long-Term Assets (PP&E Property Plant & Equipment): long term physical assets that
companies use to generate revenue. There are also tangible long-term assets
3.1.2 Recording an Asset Purchase Transaction
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$5,345 for chairs and tables purchased by the café with cash.
o DR. Furniture and Fixtures $5,345
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CR. Cash
$5,345
o To record the purchase of chairs and tables
3.1.3 The Concept of Depreciation
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PP&E are tangible assets
Depreciation: an accounting method that allocates the depreciable cost of an asset over the
asset’s estimated useful life.
o Sometimes referred to as amortization
o COA account called “depreciation expense” or “amortization expense”
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Companies that prep financial statements assume the company is a going concern that
will use long-term assets for future years
o Land is not depreciable
1. Depreciable Cost: the total cost of an asset that is depreciated over the asset’s useful life
minus the estimated residual value of that asset.
o Total cost of an asset includes the cost of an asset and any cost directly attributable to
the asset, such as costs to deliver and install the asset for its intended use
2. An Asset’s Estimated Residual Value: is the amount the company expects to receive when
the asset is sold at the end of its useful life
o net of any disposition costs such as marketing the asset to find a buyer or paying legal
fees
3. An Asset’s Estimated Useful Life: the period in which an asset is expected to contribute
directly or indirectly to the future cash flows of a company
Balance Sheet
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Depreciable Cost = [ Total Asset Cost (Cost to purchase the asset + Cost directly
attributable to an asset to get it ready for its intended use)] – Estimated residual value
o Tophat Question 3.1.3 Q5
 Computer cost $3000
 Estimated Useful Life = 3 yrs
 Residual Value = $300
 Office desk $1500 and chair $700
 Estimated Useful Life = 5 yrs
 Delivery fee for office furniture $150
 2200-150-0
o Tophat Question 3.1.3 Q6
 Computer cost $3000
 Estimated useful life = 3 yrs
 Residual value = $300
 Furniture $1500 and $700
 Estimated useful life = 5 yrs
 Delivery fee = $150
 2200-150=2050
It wouldn’t make sense to expense the entire cost of a long-term asset on the income statement
in the period in which it was purchased
o This is because companies use these resources to generate cash flows in future periods
o Thus, due to the matching principle, their cost must be allocated to all periods where
the asset is expected to contribute to the generation of revenue.
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PP&E purchases meet the definition of an asset and are initially recorded in the balance sheet at
the total asset cost, including cost directly attributable to getting the asset ready for its indeded
use.
Depreciable cost is transferred from the balance sheet  income statement as an expense over
the asset’s useful life
o Every period, the amount recorded in the balance sheet decreases and depreciation
expense increases.
Accumulated Depreciation
o Calculates the asset’s net book value in the balance sheet, net the total depreciation
that has been recognized as depreciation expense in the income statement
o J/E
 DR. Depreciation expense $X
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CR. Accumulated depreciation $X
 To record depreciation for the period
o In the Balance Sheet, the asset is recorded as follows:
 PP&E asset, original cost
$A
 Less: Accumulated depreciation – PP&E asset $B
 PP&E, net
$C (formula: $A - $B)
o Long-term assets gets used over time and will get closer to the residual value as it nears
the end of its useful life
 When an asset reaches the end of its useful life, it is fully depreciated and the
amount left over in the balance sheet is the residual value
 Depreciable cost is 0
 Depreciable cost = Total asset cost – Residual value
 0 = Net Book Value* - Residual value
o *Net Book Value (end of useful life) = Residual value
 *NBV = Asset cost – Accumulated depreciation
o Gain/Loss on Asset Disposal: an account used to record the gains or losses from selling
assets for more or less than their residual values.
 this is not accounted for as revenue or contra revenue.
 Revenue for ESI should only include sales of clothing and accessories
o Loss on disposal (asset sold less than residual value)
 DR. Cash
$Y
 DR. Gain / Loss on asset disposal
$Z
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CR. Long-term asset account
$X (residual value)
 To record the sale of a fully depreciated asset
o Gain on disposal (asset sold more than residual value)
 DR. Cash
$Y
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CR. Long-term asset account
$X (residual value)
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CR. Gain / Loss on asset disposal
$Z
 To record the sale of a fully depreciated asset
3.1.4 Methods of Depreciation
ASPE Permitted Depreciation Methods:
(chosen based on asset’s expected revenue generation)
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Straight-Line Method:
o charges the cost of the asset to the income statement evenly throughout its useful life
o Used when long-term assets generate revenue evenly throughout their useful life
Variable Change Method:
o A method of depreciation which charges the cost of the asset to the income statement
based on the usage of the asset
o Used when long-term assets wear out based on usage
Decreasing Charge Method:
o A method of depreciation which charges the cost of the asset to the income statement
based on higher initial charges that decrease over its useful life
o Used when long term assets generate more revenue in the initial years and less in the
latter part of their life
Straight-Line Method
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Charges cost of the asset to the income statement evenly throughout its useful life
Usually applied when it’s estimated that the tangible long-term asset will generate revenue
evenly throughout its useful life.
Annual Depreciation Expense
o Asset’s Depreciable Cost / Asset’s Estimated Useful Life (in years)
Monthly Depreciation Expense
o Asset’s Depreciable Cost / Asset’s Estimate Useful Life (in months)
Variable Charge Method
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Charges cost of asset to the income statement based on usage of the asset
This method should be applied when the company believes the usage of the asset will vary
significantly in each year of the asset’s useful life
Decreasing Charge Method
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Charges cost of asset to the income statement based on higher initial charges that decrease
over its useful life.
This method should be applied when long-term assets generate more revenue in the initial
years, and less in the latter part of their useful life. Matching principle is more accurately
followed this way
3.1.5 Tangible Long-Term Asset Complexities
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Accounting Topics related to Tangible Long-Term Assets
o Changes to estimated useful life and/or estimated residual value
o Depreciation for partial periods
o Disposing or selling a tangible long-term asset before the end of its useful life
o Leasehold improvements
Changes to estimated useful life and/or estimated residual value
o Usually are estimates made by management
o Physical dmg and significant tech developments can change estimates
o If estimates change, the already charged depreciation expense to the income statement
remains unaffected.
o With straight-line method, the depreciation expense that is charged for the remaining
periods must be recalculated
 ( Net book value of PP&E asset at date of change – residual value at date of
change ) / Remaining useful life at date of change
Depreciation for Partial Periods
o Most companies don’t purchase tangible long-term assets at the beginning of a period,
they purchase assets throughout the period as necessary
 E.g if a tangible long-term asset is purchased mid-month, the company records
depreciation expense only for part of the month as follows
 Monthly depreciation expense * ( (Total days in the month – date of purchase) /
total days of the month )
 E.g August 13th
 Monthly depreciation expense * ((31 Days in Aug – 13) / 31 Days in Aug)
Disposing or selling a tangible long-term asset before the end of its useful life
o Disposal of an asset pre end of useful life must be recorded as a transaction in the
books.
o When disposed or sold, need to calculate gain / loss on asset disposal
 Proceeds from sale/disposal – Asset net book value
 If amount is positive
o Record a gain by crediting the gain/loss on asset disposal
account
 If amount is negative
o Record a loss by debiting the gain/loss on asset disposal account
Leasehold Improvements
o Money spent to make a rented tangible long-term asset useful for its specific intended
use
 E.g rent office building
3.2 Financing Tangible Long-Term Assets
3.2.1 How to Finance a Tangible Long-Term Asset
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For companies to be able to purchase tangible long-term assets, they must obtain financing
Private companies typically obtain financing from
o Cash on hand (finance internally)
o Borrow money from a bank (debt financing)
o Raise money from private investors (equity financing)
Working Capital:
o Cash for day-to-day operations
3.2.2 Debt Financing
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Line of Credit: borrowing money from banks to obtain money for operations and investments
o common way for companies to borrow money from a bank for day-to-day operations.
o The loans are either short-term in nature and classified as short-term debt as companies
typically repay within 12 months
o Not typically used to purchase tangible long-term assets
Long-Term Loans: money lent by a bank to a company to purchase long-term assets
Interest: when a bank lends money to a company, interest is charged on the amount of the loan
that remains outstanding
o Interest Rate: the cost to borrow money from a bank, expressed as a %.
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Principal Payments: periodic payments made to the bank to repay the amount borrowed
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Interest Payments: periodic charges paid to a bank when money is borrowed
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Interest is calculated based on the beginning long-term loan balance