FINANCIAL ACCOUNTING
A USER PERSPECTIVE
Hoskin • Fizzell • Davidson
Second Canadian Edition
Capital Assets
Chapter Eight
Capital Asset Recognition
• Capital assets
– Used to generate revenue over
several periods in the future
– Used until replaced with a new
asset
– Can have residual (or resale) value
Capital Asset Valuation
• Historical cost
– Original cost of the asset
– Expensed (amortized) over the
period used
Capital Asset Valuation
• Gain or loss on sale
– Recognized only when sold
– Difference between proceeds of the
sale and the net book value
• Net book value (or carrying value)
– Original cost less amortization
Capital Asset Valuation
• Market value
– Replacement cost
• Amount that would be needed to
acquire an equivalent asset
– Net realizable value
• Amount that could be received by
converting the asset to cash
Capital Asset Valuation
• Canadian practice
– Uses historical cost
– Amortized over the period of use
• Maximum of 40 years
– Market value changes generally not
recognized
Capitalizable Costs
• Costs to acquire and prepare the
asset for use
– Purchase price (less any discounts)
– Installation costs
– Transportation costs
– Legal costs
– Direct taxes
Basket Purchases
• Several assets acquires in one
transaction
• Price paid is divided between the
assets on the basis of their
relative fair values at the time of
acquisition
Basket Purchases
Timberland Example
Asset
Fair market Percentage Purchase price
value
of fair value
allocated
Land
$ 300,000
25%
$ 250,000
900,000
75%
750,000
$1,200,000
100%
$1,000,000
Timber
Interest Capitalization
• Companies often borrow money
to finance a capital asset
• Interest paid on borrowed money
– Capitalized when it is included in
the capital asset account rather than
being expensed
Amortization (or Depreciation)
• Method for allocating the cost of
capital assets to the periods in
which the benefits from the assets
are received (the useful life)
• Does not refer to the value of the
asset
• Follows the matching concept
Amortization Methods
• Straight-line method
• Accelerated or diminishing
balance method
• Decelerated method
• Unit of production method
Amortization Methods
Asset Carrying Value
12
D
o
l
l
a
r
s
10
8
Straight-line
Accelerated
Decelerated
6
4
2
0
Year 5
Year 10
Year 15
Year 20
Amortization Methods
Amortization Expense
0.8
D
o
l
l
a
r
s
0.7
0.6
0.5
Straight-line
Accelerated
Decelerated
0.4
0.3
0.2
0.1
0
Year 5
Year 10
Year 15
Year 20
Straight-Line Method
• Allocates the cost evenly over the
life of the asset
• Estimates needed for
– Useful life
– Residual value
Straight-Line Method
• Assumptions:
– Original Cost
– Estimated
• Residual Value
• Useful Life
$10,000
$1,000
5 years
Straight-Line Method
Amortization
Expense
Original Cost
=
=
=
-
Residual Value
Useful Life
$10,000
-
$1,000
5 years
$1,800 per year
Straight-Line Method
Amortization Schedule
Year Book Value Amortization
Beginning
Expense
1
$10,000
$ 1,800
2
8,200
1,800
3
6,400
1,800
4
4,600
1,800
5
2,800
1,800
$ 9,000
Accelerated Methods
• Amortization
– Multiply the carrying value of the
asset by a fixed percentage
• Carrying value decreases each
year
• Amortization expenses decreases
each year
Accelerated Methods
• Percentage rates
– Lower when asset has longer life
• Double declining balance method
– Percentage is double the straightline rate
– Residual value
• Not used for computations
• Serves as a constraint
Double Declining Balance
Method
• Assumptions:
– Original Cost
– Estimated
• Residual Value
• Useful Life
$10,000
$1,000
5 years
– 200% Declining Balance Method
Double Declining Balance
Method
• Calculation:
DB rate
= DB% x SL rate
= 200% x 1/n
= 200% x 1/5
= 40%
Double Declining Balance
Method
Amortization Schedule
Year Balance Accum. Net Book % Amort.
in PP&E Amort. Value
Expense
1 $10,000 $
0 $10,000 40 $ 4,000
2
10,000
4,000
6,000
40
2,400
3
10,000
6,400
3,600 40
1,440
4
10,000
7,840
2,160 40
864
5
10,000
8,704
1,296 40
296
$ 9,000
Production Method
• Assumptions
– Benefits derived are related to the
output or use of an asset
• Requires that the useful life can
be expressed as units of output
Production Method
• Assumptions:
– Original Cost
$10,000
– Estimated Residual Value $1,000
– Estimated Usage
Year 1
Year 2
Year 3
Year 4
Year 5
5,000 units
4,500 units
5,500 units
3,000 units
2,000 units
20,000 units
Production Method
Amortization
Expense per
Unit
-
Cost
=
=
=
Residual Value
Estimated Total Units of Output
$10,000
-
$1,000
20,000 units
$0.45 per unit
Production Methods
Amortization Schedule
Year Cost per
Units
Expense
Unit
Used
1
$ 0.45
5,000
$ 2,250
2
0.45
4,500
2,025
3
0.45
5,500
2,475
4
0.45
3,000
1,350
5
0.45
2,000
900
$ 9,000
Recording Amortization Expense
• All amortization methods:
SE-Amortization expense XX
XA-Accumulated
amortization
XX
Corporate Income Taxes
• Revenue Canada
– Amortization expense is allowed to
be deducted to calculate
accounting income
– Capital cost allowance (CCA)
instead must be used to calculate
taxable income
Corporate Income Taxes
• May result in a temporary
difference between Accounting
income and taxable income
• Result is a future tax asset or
liability (formerly referred to as
deferred tax)
Capital Cost Allowance (CCA)
• Capital assets are grouped into
classes and assigned a maximum
rate
– Vehicles: Class 10: rate 30%
– Equipment: Class 8: rate 20%
Capital Cost Allowance (CCA)
• Companies may deduct any part of
the undepreciated capital costs
(UCC) in the class up to the stated
maximum
• Exception:
– Year of acquisition: 50% of normal
amount
Capital Cost Allowance (CCA)
• Central Corp. purchases new
equipment (Class 8) at a cost of
$20,000
• CCA
Year 1: 50% x $20,000 x 20% = $2,000
Year 2: 20% x ($20,000-$2,000)= $3,600
Year 3: 20% x ($20,000-$2,000-$3,600) = $2,880
Capital Cost Allowance (CCA)
• Journal entry:
SE-Tax expense
11,460
A-Future tax asset*
90
L-Income taxes payable
11,550
*(Future tax liability if a credit balance)
Changes in Amortization
Estimates and Methods
• Estimates of useful life and
residual value may change over
time
• Amortization may change as a
result
Changes in Amortization
Estimates and Methods
• Straight-Line Method Assumptions
– Original Cost
– Residual Value
– Useful Life
$10,000
$1,000
5 years
• Changes in Year 4 (Estimations)
• Remaining Useful Life
• Residual Value
3 years
$ 400
Changes in Amortization
Estimates and Methods
Amortization
Expense
=
=
=
Remaining
Book Value
-
Residual Value
Useful Life
$4,600
-
$400
3 years
$1,400 per year
Changes in Amortization
Estimates and Methods
Amortization Schedule
Year Book Value Amortization
Beginning
Expense
1
$10,000
$ 1,800
2
8,200
1,800
3
6,400
1,800
4
4,600
1,400
5
3,200
1,400
6
1,800
1,400
$ 9,600
Sale of Capital Assets
• Original cost and accumulated
amortization removed from accounts
• Gain or loss: difference between
cash received and book value
A-Cash
1,200
XA-Accumulated amortization
9,000
A-Property, plant and equipment
10,000
SE-Gain on sale of PP&E
200
Disposal of Capital Assets
• If assets are disposed of and no
cash is received
XA-Accumulated amortization
9,000
SE-Loss on disposal of PP&E
1,000
A-Property, plant and equipment
10,000
Writedown of Capital Assets
• If future recoverable amount of a
capital asset declines below its
carrying value
SE-Loss due to damage to asset 1,000
XA-Accumulated amortization
1,000
Natural Resources
• Capitalizing the costs implies that
they have future value
• Example: oil exploration
• Exploration costs choices
– Full costing method
– Successful efforts method
Intangible Assets
• Intangible assets have probable
future value but no physical form
• Guidelines:
– If developed internally, expense as
incurred
– If purchased, can be capitalized
Intangible Assets
• Estimate useful life and residual
value (if any)
• Use straight-line method to
amortize
SE-Amortization expense
A-Patents
XX
XX
Intangible Assets
• Advertising
– Generally expensed as incurred
• Patents, Trademarks, Copyrights
– Legal life is the maximum for
amortizing
• Goodwill
– Capitalize and amortize if purchased
Return on Assets
ROA =
Net income before interest
Average total assets
Net income + [Interest expense
x (1-Tax rate)]
=
Average total assets