Chapter 12
Capital Assets and Goodwill
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
In this chapter…
Balance Sheet
Current Assets
Cash
Chapter
Current Liabilities
Chapter
10000
Accounts Payable
Accounts Receivable
20000
Wages Payable
Notes Receivable
15000
Utilities Payable
Marketable Securities
25000 Long-Term Debt
Inventory
120000
Capital Assets
2000
20000
Bonds Payable
600000
12
250000 Owner’s Equity
Buildings
12
500000
12
60000
Total Assets
25000
Notes Payable
Equipment
Goodwill
5000
Common Stock
300000
Retained Earnings
48000
1000000 Total Liabilities + OE
1000000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Capital Assets
• Capital Assets – assets used in the operations of a company and
have a useful life of more than one accounting period
– (Generally, we don’t use the term “Capital Assets” any more under the
new IFRS rules)
• Generally divided into 2 groups
– Tangible Assets – Property, Plant and Equipment
– Intangible Assets – patents, copyrights, trademarks (excluding goodwill)
• The IFRS defines an intangible asset as an identifiable, non-monetary asset
without physical substance that provides future economic benefit
• The three major accounting issues to examine are
– The accounting for initial and subsequent costs
– Allocating costs of capital assets against revenues
– Recording the disposal of the capital assets
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Costs of Capital Assets
• Capital assets are recorded at cost, which includes normal
and reasonable expenditures to get the asset to a place
where it can be useful
– Freight, packing and unpacking costs, installation costs, nonrefundable taxes
– These are known as capital expenditures
• Capital Expenditures are costs relating to capital assets that
provide a benefit beyond the current period.
– They are added to the capital assets line and depreciated along with
the capital assets over time.
• Revenue Expenditures – costs that improve the asset but
which do not increase its useful life or productive
capabilities.
– They are recorded as expenses and deducted in the current period.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Land
• Land is a special asset. It can’t be depreciated.
– But stuff on the land, like buildings, parking lots, etc are
depreciated.
• Cost of land will include its price, real estate commissions,
insurance for titles, legal fees and accrued property taxes
• Costs relating to land preparation for building are also
added to the cost of the land
• Costs relating to removing old unwanted buildings or scrap
can also be added to the land. If those are sold for salvage,
then the salvage amount is subtracted from the land costs
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Buildings
• Building costs include its purchase price, commissions,
taxes, legal and title fees. These are all costs needed to
make the building ready for use.
• Buildings are depreciated over a defined useful life
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Leasehold Improvements
• Leasehold Improvements – these are improvements made to land
or buildings under lease by a lessee
– Lease – the contract under which the property is rented
– Lessor – the property owner renting the property
– Lessee – the organization renting the property
• Long term leases often will look and feel as if the lessee actually
owns the property.
– This is why improvements to leased property need to be depreciated.
– They are depreciated either over the useful life of the improvements or
over the life of the lease.
• Leasehold improvements are amortized over the life of the lease
or the life of the improvements – whichever is shorter
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Machinery and Equipment
• Machinery and Equipment costs include the purchase
price, plus installation, transportation, non-refundable
taxes, insurance, etc
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Amortization and Depreciation
• Capital Assets wear out over time or decline in usefulness
• Amortization (intangible assets) or depreciation (tangible assets)
is the process of matching or allocating the cost of the capital
assets over the time that the asset is used.
– In effect, accounting is trying to use the matching principle to match the
cost of the assets to the revenues they helped create.
– You can think of the original purchase as the outlay of cash for the asset.
However, the expensing of that asset is postponed until that portion of the
asset is used to create a future portion of revenue
• Note that amortization is a process of cost allocation NOT asset
valuation.
– Amortization is not a measure of an assets declining market value
• Start recording asset depreciation once the asset is put into use
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Reporting Asset Depreciation
• As we have seen,
– The cost and accumulated depreciation is reported on the balance
sheet
• These can be shown as separate line items or as a Net amount
– The depreciation expense for the period is shown on the income
statement
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Calculating Depreciation
• Cost – the cost of the capital asset including all reasonable
costs needed to acquire it and prepare it for use
• Salvage Value – aka Residual Value, is an estimate of the
amount that the asset could be sold for at the end of its
useful life
• Useful Life – aka Serviceable Life, the length of time over
which the asset is productive
– Different types of assets will have different useful lives
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Depreciation Methods
• 3 Depreciation Methods
– Straight-line depreciation or amortization
– Units of Production
– Double declining balance
• Straight-line Method
– Charges the same amount to Depreciation expense for each period of the
assets useful life
– Depreciation Expense = (Total Cost – Salvage Value)/No. useful periods
Date
Account Titles and explanation
Jan 31
Depreciation Expense
PR
Acc. Dep.
Debit
Credit
750
750
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Depreciation Methods
• Straight-line Method, con’t
– The Depreciation expense for the asset is always the same from
period to period.
– The accumulated Depreciation is the sum of this and all previous
periods’ amortization expenses
– When we draw a graph showing the book value of the asset, it is a
straight line declining toward the salvage value
Truck Book Value
20000
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
1
2
3
4 Accounting
5
6
7
Financial
Dave Ludwick, P.Eng,Year
MBA, PMP
8
9
10
Depreciation Methods
• Units of Production Method
– This method charges a varying amount of expense for each period
depending on the amount of usage
– Two step Process
• Calculate the Depreciation on a per unit basis
– Deprec. = (Total Cost – Salvage Value)/Total Estimated Production
Units)
• Calculate Depreciation for the period, by multiplying the above unit
based amortization rate by the number of units produced in the period
– This method is preferred over the straight-line method, when the
equipment is not used evenly from period to period.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Depreciation Methods
• Declining-balance Method
– This is an accelerated depreciation method: It allocates
comparatively more to depreciation expense in early years and
smaller amounts in later years
• The rate of the acceleration can be different for each asset (but must
be consistent over the life of that asset)
• The amount of depreciation expense applied is based on the book
value in that period.
– This methods attempts to more closely approximate the value of
the asset over its life
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Depreciation Methods
• Declining-balance Method
– Two Step Process
• Calculate the declining balance rate
• Calculate the depreciation expense by multiplying the rate by the
asset’s beginning of period book value.
– Look at Exhibits 12.14 and 12.15
•
•
•
•
In this case they are using Double-declining balance
Step 1: Rate = 2/Estimated Useful Life
Step 2: First year Deprec. Exp. = Rate * Beg. Period Book Value
Step 3:
– Next year Beg. Balance = Previous year beg balance – Deprec. Exp.
• Notice how the Beg. Period book value is the previous period’s end of
period book value
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Depreciation Methods for Tax Purposes
• For tax purposes, companies must use a declining balance
method for calculating the maximum allowable Capital
Cost Allowance
• Capital Cost Allowance (CCA) – is depreciation for tax
purposes
• There is a different CCA rate for various different asset
classes. Different types of assets are assigned to a class
which determines the CCA rate
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Partial-Year Depreciation
• Assets are not always acquired at the beginning of a period
• To account for this, there are 2 ways to calculate the first
year’s depreciation expense
• Nearest Whole Month
– If the asset is purchased in the first part of a month, that whole
month and all months after it until the end of the period are
considered the first year
– Example: A machine is purchased for $10000 on April 8, with a
fiscal year end of Dec 31 and salvage value of $1000 in 5 years
– First Year Depreciation = [(Cost – Salvage Value)/Estimate useful
life]* 9/12
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Partial-Year Depreciation
• Half-Year Rule
– The materiality principal may allow a company to simply use the
half year rule for the first year’s depreciation amount
– The Half-Year Rule says the regardless of when the asset was
purchased, only half of the depreciation is allocated in the first
year.
– The process is to calculate what normally would be the first year’s
depreciation, then multiply it by half.
• This applies to all the depreciation calculation methods except Units
of Production
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Net Book Value
• Net Book Value = Original Cost – Accumulated depreciation
– Regardless of the method used to calculate depreciation expense, Net
Book Value is always the original cost less the accumulated depreciation
• Things to remember
– Depreciation expense is an income statement account that is the amount
of depreciation taken just for that period
– Accumulated depreciation is the sum total of all the depreciations ever
taken for that asset. It is a balance sheet account
– So, …
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Net Book Value
• The asset account never changes from when the asset was
bought
• The Deprec. Expense account gets a new entry every period
– Remember it gets cleared out at the end of the previous period by the
Chapter 5 closing process
• The Accum. Deprec. account just keeps getting bigger until it
equals the original asset cost
Building
Aug 31
Accumulated Depreciation
500000
This goes on income statement
Depreciation Expense
Dec ‘10
20000
This goes on balance sheet
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
20000
Dec ‘08
20000
Dec ’09
20000
Dec ’10
60000
Total
Net Book Value
Balance Sheet
Current Assets
Cash
Income Statement
10000
Current Liabilities
Accounts Payable
5000
AR
20000
Wages Payable
25000
Notes Receivable
15000
Utilities Payable
Marketable Sec.
25000
Inventory
120000
Capital Assets
Equipment
250000
Less: Acc. Depr.
(20000)
Buildings
500000
Less: Acc. Depr.
(60000)
Goodwill
Total Assets
2000
Long-Term Debt
1000000
COGS
(550000)
Gross Profit
450000
Expenses
Notes Payable
20000
Bad Debt
10000
Bonds Payable
531000
Utilities
5000
Wages
372000
Insurance
15000
Depreciation
20000
Owner’s Equity
230000
Revenue
Common Stock
Retained Earnings
300000
28000
440000
Total Expenses
341000
60000
911000
Total Liabilities + OE
911000
Net Book Value
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Net Income
28000
Mid-Chapter Demonstration Problem
• Lets look at the Mid-Chapter Demo problem
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Disposal of Capital Assets
• Assets can be disposed of for many reasons, but generally
the process for recording their disposal is as follows:
– Up to the point of sale, calculate the Acc. Dep. and Depreciation
Expense as normal
– When the sale is made, you must clear out the Acc. Dep. and the
asset – since it is now gone
– Record the receipt of the cash
– Record a Gain or Loss
• Note: If/When there is a Gain or Loss, the Gain or Loss is like
Revenue or Expense type of account.
• A Gain or Loss is of type: “Other Income” or “Other Loss”
• On the income statement it is shown down below after all operating
information
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Discarding a Capital Asset
• Discarding a capital asset means it is no longer used, and it
has no market value
• If we are discarding an asset that still has some
undepreciated cost, we complete the depreciation to the
date of disposal then record a loss
• Example: Some equipment is discarded on July 1 that had
Acc Dep to that point of 6500, but was bought for 8000
Date
Account Titles and explanation
PR
July 1
Acc Dep.
6500
Loss on Discarded Equipment
1500
Equipment
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Debit
Credit
8000
Selling a Capital Asset
• When selling the asset, the cash portion must also be
considered.
– The journal entry will take the cash, zero out both the Acc.Dep.
and the asset’s cost and take the difference up as a gain or loss
– Example: The equipment was sold for 7000. It was originally
bought for 16000 and had Acc. Dep. of 13000 to date.
– The Gain takes up the difference between the Debits and Credits
Date
Account Titles and explanation
PR
Debit
July 1
Cash
7000
Acc. Dep. Equipment
13000
Credit
Gain on sale of assets
4000
Equipment
16000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Exchanging Capital Assets
• Exchanges or trade-ins are counted as a combination of a sale
of the old asset and purchase of a new asset at the same time.
Again, the process is similar to the previous:
– Bring in the new asset, zero out the old asset’s account and Acc. Dep.
– Bring in the cash and account for the difference as a Gain or Loss
– Ex: Trade in a $30000 car for a $40000 trailer plus pay $21000
Date
Account Titles and explanation
PR
Debit
July 1
Trailer
40000
Acc. Dep. Car
12000
Credit
Car
30000
Cash
21000
Gain on Trade of Car
1000
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Demonstration Problem
• Lets try the Demonstration problem
– Assume the company uses straight-line depreciation
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Natural Resources
• Natural Resources are considered tangible assets. When they are
still in their natural state they are considered capital assets
• They are initially recorded at cost and have an amortization and
accumulated amortization just like other capital assets.
• The rate of the amortization is based on units extracted – similar
to the Units of Production Method
– Step 1: Depreciation per unit = (Cost – Salvage)/Total Units
– Step 2: Depreciation Expense = Depr. Per unit * No. Units extracted in
the period
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Natural Resources
• Once the material is extracted, it can either be sold or
stored for future sale
• The portion sold is rolled into accumulated depreciation
• The portion unsold is saved on the Balance Sheet as a
current asset.
– Say we owned $1,000,000 of ore deposits, extracted $100000
worth and sold $80000 of it for $160000:
– The cost side of this event is:
Date
Account Titles and explanation
PR
Debit
Dec 31 Unsold Ore Inventory
20000
Depreciation Expense
80000
Acc. Dep. - Ore
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Credit
100000
Intangible Assets
• Intangible Assets are capital assets. Examples are
– Rights, privileges, competitive advantages, trademarks, copyrights
• Goodwill is an intangible asset but not considered a capital
asset
– It is always shown separately on the balance sheet
• Accounting for intangible assets is just like that for
tangible assets
– They are recorded at cost. They are amortized over time in a
systematic way (only the Straight-line Method is used)
– When disposed, a Gain or Loss is recorded
– Note: Usually no Acc.Amort. Is kept – we just credit directly to the
intangible capital asset account.
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Goodwill
• Goodwill is an intangible asset. It is the amount by which the
price paid for a company exceeds the fair market value of its net
assets, if they were to be purchased separately
– Goodwill represents the company's value beyond just its assets (Ex:
Strong customer base, management skills, expected future cash flow)
Date
Account Titles and explanation
PR
Debit
Jan 1
Assets Purchased
7000000
Goodwill
60000
Credit
Liabilities acquired
2000000
Cash
5060000
• Goodwill is only generated from the purchase of a company.
– A company cannot establish its own goodwill
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Exercises
• Try Problems 12-3A, 12-10A and 12-13A
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD