Types of Expenditures z Revenue Expenditure immediately charged

Types of Expenditures z. Revenue Expenditure immediately charged against revenue as an expense. z. Capital Expenditure increase the company’s investment in productive activity. 1

Plant Assets. . . z. Are resources that: yhave physical substance; yare used in the operations of a; business yare not intended for sale to customers. z. Are recorded at cost. ycost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. 2

Plant Assets z. Cost is measured by: ythe cash paid in a cash transaction, or ythe cash equivalent price paid when noncash assets are used in payment. z. The cash equivalent price is equal to: ythe fair market value of the asset given up, or ythe fair market value of the asset received, whichever is more clearly determinable. 3

Plant Assets z. Land - a building site, manufacturing site, office site. z. Land improvements z. Buildings z. Equipment 4

Cost of Land Includes: zthe cash purchase price zclosing costs such as title and attorney's fees zreal estate brokers commissions zaccrued property taxes and other liens on the land assumed by the purchaser. 5

Cost of Land Improvements Include: z. All expenditures necessary to make the improvements ready for their intended use. Examples: y. Drive ways y. Parking lots y. Fences y. Underground sprinklers 6

Buildings Include: z. All necessary expenditures relating to the purchase or construction of a building. z. Examples y. Stores y. Offices y. Factories y. Warehouses y. Airplane Hangers 7

Cost of Buildings Include: z. All necessary expenditures relating to the purchase or construction of a building. z. When a building is purchased such costs include the: ypurchase price yclosing costs (attorney's fees title insurance) yreal estate broker's commissions. 8

Cost of Buildings Include: z. Cost of making a building ready for its intended use consist of: yexpenditures for remodeling rooms or offices yreplacing or repairing xroof xfloors xelectrical wiring xplumbing 9

Buildings When a building is constructed, its cost consists of: ythe contract price yarchitect's fees ybuilding permits yexcavation cost yinterest costs during construction. 10

Examples of Equipment z. Store check-out counter z. Office furniture z. Factory Machinery z. Delivery Equipment y. Trucks y. Airplanes 11

Cost of Equipment Includes: zpurchase price zsales tax zfreight charges and insurance during transit paid by the purchaser zexpenditures required in assembling zinstalling and testing the unit. 12

Equipment z. Two criteria apply in determining the cost of equipment: ythe frequency of cost - one time or recurring ythe benefit period - the life of the asset or 1 year. 13

Advantages of Leasing an Asset Versus Puchasing z. Reduced risk of obsolescence z. Little or no down payment z. Shared tax advantages z. Assets and liabilities not reported 14

Depreciation z. Applies to three classes of plant assets: y. Land improvements y. Buildings y. Equipment. y. NOT LAND! 15

Depreciable Assets The revenue-producing ability of an asset declines during its useful life because of wear and tear. A decline in revenueproducing ability may also occur because of obsolescence. 16

Depreciation is… z The process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner. z A process of cost allocation, not a process of asset valuation. 17

Land Does not depreciate since its usefulness and revenue producing ability generally remain intact, or increase. 18

Accumulated Depreciation z. The balance in Accumulated Depreciation is not a cash fund. SH CA 19

Factors in Computing Depreciation New ART 20

Affects of Depreciation z. Depreciation affects the balance sheet through accumulated depreciation, which is reported as a reduction from plant assets. z. Depreciation affects the income statement through depreciation expense. 21

Depreciation Methods z. Straight-line z. Declining-balance z. Units-of-activity 22

Straight-line Method Depreciable Cost* ____________________________________________________ The asset's useful life measured in years *(cost of the asset less its salvage value) 23

Straight-Line Depreciation Formula 24

Year 25 2004 2003 2002 z. Is the most widely used method of depreciation. z. Depreciation is the same for each year of the asset's useful life. 2001 Straight-line Method

Partial Year Depreciation If an asset is purchased during the year rather than on January 1, the annual depreciation is prorated for the proportion of a year it is used. 26

Year 27 2005 2004 2003 2002 z Is an accelerated method. z Accelerated methods of depreciation result in more depreciation in the early years of an asset's life and less depreciation in the later years. 2001 Declining-Balance Method

Year 28 2005 2004 2003 2002 The life of an asset is expressed in terms of the total units of production or the use expected from the asset. 2001 Units-of-Activity Method

Depreciation and Income Taxes z. The IRS allows corporate taxpayers to deduct depreciation when computing taxable income. z. The IRS does not require the taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements. 29

Depreciation and Income Taxes z. Many large corporations use straight-line depreciation in their financial statements to maximize net income. z. At the same time they use a special accelerated-depreciation method on their tax returns to minimize their income taxes. 30

Depreciation and Income Taxes z. For tax purposes: ythe straight-line method or ya special accelerated-depreciation method called the x. Modified x. Accelerated x. Cost x. Recovery x. System z. The choice of depreciation method must be disclosed in the notes to financial statements. 31

Revising Periodic Depreciation z When a change in an estimate is required, the change is made in current and future years but not to prior periods. z Significant changes in estimates must be disclosed in the financial statements. z Extending an asset's estimated life reduces depreciation expense and increases net income for the period. 32

Ordinary Repairs z. Expenditures to maintain the operating efficiency and expected productive life of the asset. z. Are usually small in amount that occur frequently throughout the service life. 33

Ordinary Repairs z. Examples: ymotor tune-ups y oil changes y the painting of buildings ythe replacing of worn-out gears Ordinary repairs increase Repair Expense and are revenue expenditures. 34

Additions and Improvements z. Costs incurred to increase the: yoperating efficiency yproductive capacity or y expected useful life of the plant asset. z. Are usually material in amount and occur infrequently during the period of ownership. z. Are capital expenditures. 35

Impairment z. A permanent decline in the market value of an asset. z. Is written down to the new market value during the year in which the decline occurs. 36

Plant Asset Disposals The depreciation for the fraction of the year to the date of disposal must be recorded. Depreciation Expense Accumulated Depreciation 8, 000 Compute Book Value: Book Value = Cost - Accumulated Depreciation 37

Sale of Plant Assets z In the sale of an asset, the book value of the asset is compared with the proceeds from the sale. z If the proceeds exceed the book value a gain on disposal occurs. z Conversely, if proceeds from the sale are less than the book value a loss on disposal occurs. 38

Retirement of Plant Assets z. Is recorded by decreasing Accumulated Depreciation for the full amount of depreciation taken over the life of the asset. z. The asset account is reduced for the original cost of the asset. z. The loss is equal to the asset's book value at the time of retirement. 39

Analyzing Plant Assets The two measures by which plant assets are evaluated are: z. Returns on Asset Ratio z. Asset Turnover Ratio 40

Return on Assets Ratio Indicates the amount of net income generated by each dollar invested in assets Net Income Average Assets 41

Asset Turnover Ratio z z z Indicates: How efficiently a company uses its assets? How many dollars of sales are generated by each dollar invested in assets? Net Sales Average Total Assets 42

Asset Turnover Ratio Two ways a company can increase its return on assets: z. Increase profit per sale--measured by profit margin ratio. z. Increase its volume of sales-measured by the asset turnover ratio= Net Sales Average Total Assets 43

Intangible Assets are yrights yprivileges ycompetitive advantages that result from ownership of long-lived assets that do not possess physical substance. 44

Amortization. . . Allocation of the cost of an intangible asset to expense over the shorter of: zits useful (economic) life zits legal life z 40 years 45

Types of Intangible Assets z. Patents z. Copyrights z. Trademark or Trade Names z. Franchises and Licenses z. Goodwill PATENT 46

Patents An exclusive right issued by the U. S. Patent Office that enables the recipient to manufacture, sell, or control a patent for 17 years from the date of grant. 47

Patents z. The initial cost of a patent is cash or cash equivalent price paid to acquire the patent. z. Legal costs of protecting a patent in an infringement suit are added to the Patent account and amortized over the remaining life of the patent. 48

Research and Development Costs Because of the uncertainty of identifying the extent and timing of future benefits, these costs are usually recorded as an expense when incurred. 49

Average Age of Plant Assets z. Most companies use straight-line depreciation for financial reporting. Average of plant assets = Accumulated Depreciation Expense 50

Copyrights z. Copyrights are granted by the federal government giving the owner the exclusive right to reproduce and sell artistic or published work. z. Copyrights extend for the life of the creator plus 50 years. 51

Licenses z. Operating rights granted by a government body permit the enterprise to use public property in performing its service (i. e. the use of airwaves for radio or TV broadcasting). 52

Costs Associated with Franchise or License z. When costs can be identified with the acquisition of the franchise or license, an intangible asset should be recognized. z. Annual payments made under a franchise agreement should be recorded as operating expenses. 53

Goodwill represents the value of all favorable attributes that relate to a business enterprise, including: yexceptional management ydesirable location ygood customer relations yskilled employees, etc. 54