Acct 230 1st Edition Lecture 20 Outline of Last Lecture I Long Term Assets a Acquisition and Improvements Outline of Current Lecture II Long Term Assets a Asset Disposition Current Lecture III Asset Disposition a Disposal of Long Term Assets i Long term assets can be sold retired or exchanged for other assets ii A sale is the most likely Selling a long term asset can result in either a gain or a loss iii When a long term asset is no longer useful but cannot be sold we have a retirement For example Little King Sandwiches might physically remove a baking oven that no longer works and also remove it from the accounting records through a retirement entry iv An exchange occurs when two companies trade assets In a trade we often use cash to make up for any difference in fair value between the assets v Recording Long Term Asset Disposals 1 To illustrate the recording of disposals let s return to our delivery truck example for Little King Sandwiches Assume Little King uses straight line depreciation in all cases sale retirement and exchange 2 Little King Sandwiches a local submarine sandwich restaurant purchased a new delivery truck Here are the specific details a Cost of the new truck 40 000 b Estimated residual value 5 000 c Estimated service life 5 years These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute vi Sale 1 If we assume that Little King sells the delivery truck at the end of year 3 for 22 000 we can calculate the gain as 3 000 Note that both the delivery truck and the related accumulated depreciation account are removed vii Retirement 1 If we assume that the delivery truck is totaled in an accident at the end of year 3 we have a 19 000 loss on retirement The above entry assumes Little King did not have collision insurance coverage viii Exchange 1 Assume that Little King exchanges the delivery truck at the end of year 3 for a new truck valued at 45 000 The dealership gives Little King a trade in allowance of 23 000 on the exchange with the remaining 22 000 payable in cash We have a 4 000 gain b Asset Analysis i Now lets consider how to use actual financial statement information to analyze the profitability of a company s assets ii A more comparable measure of profitability than net income is return on assets which equals net income divided by average total assets It indicates the amount of net income generated for each dollar invested in assets iii Profit margin is net income divided by net sales This ratio provides an indication of the earnings per dollar of sales iv Asset turnover is net sales divided by average total assets In contrast to profit margin this ratio measures the sales per dollar of assets invested v Analyze the relation between these three ratios To maximize profitability a company ideally strives to increase both net income per dollar of sales profit margin and sales per dollar of assets invested asset turnover which will ultimately result in an increase in return on assets c Asset Impairment i Impairment occurs when the future cash flows future benefits generated for a long term asset fall below its book value cost minus accumulated depreciation If estimated future cash flows from the asset are below the book value we record an impairment loss The impairment loss is equal to the difference between the asset s book value and its fair value ii Reporting for impairment losses is a two step process 1 Step 1 Test for impairment The long term asset is impaired if future cash flows are less than book value 2 Step 2 If impaired record impairment loss The impairment loss is the amount by which book value exceeds fair value