Chapters 11 and 12
Long-term Operating Assets
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1. Overview of Topic
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Operational assets
◦ fixed assets, intangibles, and natural resources
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
Characteristics of fixed assets
Accounting over life cycle
◦ acquisition costs
———asset goes into operation ————
◦ depreciation
◦ costs subsequent to acquisition
———asset goes out of operation ————
◦ disposals and exchanges
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2. Acquisition Cost
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
Historical cost
Components of cost
◦ purchase price + all reasonable and necessary
costs to prepare asset for intended use
◦ land – closing costs, title search, attorney fees,
preparing land for use
◦ building – construction cost, architect fees,
contract admin fees, attorney fees
◦ equipment – freight, installation, testing, discounts
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Example
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2a. Acquisition Cost
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Self constructed assets
◦ raw materials, labor, overhead
◦ can never exceed price charged by outsider
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Cash discounts
Materiality
Deferred payment contract
Lump sum purchase
Donated assets
Asset retirement obligation
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2b. Acquisition Cost
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Capitalization of interest
◦ when done
 for self constructed assets (not land)
 assets constructed for you
 assets (inventory) constructed as discrete project
◦ amount capitalized
 avoidable interest
◦ amount capitalized = WAE x IR
 WAE are weighted by months
◦ interest rate used
 specific interest rate
 weighted average rate
◦ amount capitalized cannot exceed actual interest
◦ interest income
◦ example
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3. Costs Subsequent to Acquisition

General concepts
◦ any cost should be capitalized if it
 extends the life of the asset, or
 improves the asset

Recording expenditure
◦ can debit
 fixed asset account
 accumulated depreciation
◦ can use
 substitution approach
 new asset approach
 reduce accumulated depreciation approach
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3. Costs Subsequent to Acquisition
Repairs and maintenance
 Additions
 Improvements and replacements
 Reinstallation or rearrangement
 Materiality threshold
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4. Disposition of Fixed Assets
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Sell, retire, or abandonment
◦ accounted for same

Accounting
1. Update depreciation to date of disposal
2. Remove original cost of asset and
accumulated depreciation from the books
3. Difference between book value of asset and
proceeds recorded as gain or loss
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4. Disposition of Fixed Assets

Example
◦ On Jan 2, 2013 purchase new asset:
cost: $40,000, life: 5 years, no salvage, use SL
◦ On March 29, 2017 sell asset for $9,000
Depr Exp
2,000
Accum Depr
2,000
Cash
9,000
Accum Depr
34,000
Gain on Sale
3,000
Equipment
40,000
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5. Exchange of Nonmonetary Assets
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
Appendix A
Terms
◦ monetary asset
 represent a fixed claim to a specific number of dollars in
future (e.g., cash, A/R, securities)
◦ nonmonetary asset
 value is capable of changing in number of dollars (e.g.,
fixed assets, inventory)
◦ boot
 money paid or received in an exchange of assets
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5a. Exchange of Nonmonetary Assets
Rules
 General valuation rule

◦ Cost of new asset acquired equals
 FMV of asset given up plus boot paid or minus boot
received
 or, use FMV of asset acquired if more clearly
evident
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5b. Exchange of Nonmonetary Assets

If exchange lacks commercial substance or FMV not
determinable
◦ cost of new asset equals
 BV given up plus boot paid or minus boot received
◦ gain not allowed to be recognized (unless boot is received –
then partial recognition of gain)
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commercial substance means
◦ company expects a change in future cash flows as result of
exchange
◦ change is significant relative to FMV of assets exchanged
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Examples
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Depreciation
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1. Theory of Depreciation

Definition
◦ the systematic and rational allocation of the cost
of a fixed asset


Depreciation is an allocation method – not a
valuation method
Justification
◦ matching
◦ fluctuations in market value too difficult to
determine
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2. Depreciation Factors


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Cost – covered in Chapter 10
Salvage value – estimated
Useful life
◦ useful life vs. physical life
◦ functional factors
 changes in environment, asset inadequate for intended
purpose, obsolescence, supersession
◦ physical factors
 routine wear and tear, deterioration, effects of continual
usage, etc.
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3. Selecting Appropriate Method

Factors
◦ expected use, expected obsolescence, expected
pattern of decline in usefulness of asset, expected
contribution of asset to revenue, etc.
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Conceptually
◦ method that most clearly reflects net income

Practically
◦ method that minimizes bookkeeping expenses
◦ method that reports highest net income

Consistency
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4. Depreciation Methods
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Activity method
◦ can be based on output (e.g., units produced)
◦ can be based on inputs (e.g., operating hours
or miles)
Depr = Cost – Salvage
Exp
Life in Units
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x Productive Service
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4. Depreciation Methods
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4. Depreciation Methods
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4. Depreciation Methods
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Straight Line
◦ most commonly used method
◦ easy to use
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4. Depreciation Methods
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4. Depreciation Methods

Sum-of-the-years’ digits
◦ (cost – savage) x declining fraction
◦ numerator of fraction
 years in life of asset in reverse order
◦ denominator of fraction
 sum of the years
 compute denominator of fraction as
n (n + 1)
2
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4. Depreciation Methods
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4. Depreciation Methods

Declining balance
◦ remaining BV x fixed rate
◦ rate is a multiple of the straight line rate
 compute straight line rate as: 100% / life in years
◦ rates commonly used: 125%, 150%, 200%
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4. Depreciation Methods
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4. Depreciation Methods
Other methods
 Group and Composite methods
 Inventory method
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◦ sometimes used for large numbers of low cost assets
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Retirement and Replacement methods
◦ sometimes used if have large number of similar assets
replaced on constant schedule
◦ Retirement method
 FIFO approach
◦ Replacement method
 LIFO approach
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4. Depreciation Methods
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Partial years
◦ conventions – must be used consistently
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half year in first and last years
full year in first year and none in last year
none in first year and full year in last year
nearest month
◦ SYD
 prorate 12-month blocks of depreciation between years
◦ DB
 use partial year fraction in first year only
◦ Example
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5. Changes in Depreciation
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Change in accounting estimate
◦ method, salvage, or life
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Depreciate remaining BV over remaining life
Example
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◦
◦
◦
Cost = $11,000
Salvage = $1,000
Life = 5 years
Date Acquired = January 1, 2012
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5. Changes in Depreciation
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SL depreciation: 11,000 – 1,000 / 5 = 2,000

During 2015, changed life from 5 years to 7
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New depreciation used for 2015 and forward
BV on 1/1/2015
Cost
New Depreciation Amount
$ 11,000
Accum Depr
(2000 x 3)
$ 6,000
BV
$ 5,000
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Chapter 12
Impairments
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7. Impairments

An impairment occurs when expected
future net cash flows (undiscounted) of an
asset are less than the asset’s carrying
amount
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7. Impairments

Test for impairment
◦ review events for possible impairment
◦ apply recoverability test to determine if
impairment has occurred
 impairment occurs if sum of expected future net cash
flows (undiscounted) is less than asset’s carrying amount
◦ if impairment has occurred
 recognize impairment loss for amount by which the
carrying amount of the asset exceeds fair value of asset
 fair value is market price if active market exists
 if no market, use present value of expected future net cash flows
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7. Impairments
◦ if impaired asset is held for use
 new cost basis of asset is the reduced carrying amount
 depreciation is taken on new cost basis over asset’s
remaining useful life
 write-ups of asset’s value are not allowed
◦ if impaired asset is intended to be disposed of
 reported at the lower-of cost-or-net realizable value
 recovery of impairment loss is allowed but write-up
cannot exceed carrying amount of asset before
impairment
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7. Impairments
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