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Long Term Assets

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ANSWERSChapter 9 – Long-Term Assets This chapter will look at the topic of accounting for long-term assets which includes both tangible and intangible assets. We will be looking at how to record the purchase of such assets, how to allocate their cost over their useful lives, and how to record the sale or disposal of the assets. After you have finished this chapter, you should be able to: 1. Compute the total cost of long-term assets and record their purchase. 2. Define depreciation, compute depreciation under the three methods covered in the text, and record the annual depreciation entries. 3. Distinguish between capital and revenue expenditures. 4. Account for the disposal of depreciable assets by sale. 5. Identify the issues related to accounting for intangible assets, including research and development costs and goodwill. 6. Discuss the process required each year to determine appropriate recording of the imparement of long-term assets. Key Points to Remember: 1. Accounting principles related to long-term assets a. Cost principle should be followed when determining the cost of long-term assets The cost principle states that the cost of the asset should equal the cash or cash equivalent value of all expenditures reasonable and necessary to acquire the asset and get it ready for its intended usage. Therefore, cost such as freight, installation, sales taxes, or legal fees may be included in the cost of the asset and recorded as a debit to the asset account. b. Matching principle should be followed to allocate the cost of the asset over the useful life of the asset. The matching principle requires that you record the cost of long-term assets as an asset and then record depreciation (depletion or amortization) when the asset is used to help produce income. 2. Capital expenditures vs. revenue expenditures – a. Capital expenditure -- expenditures for the purchase or expansion of long-term assets. Capital expenditures benefit more than one accounting period. They may increase the quality or quantity of output of an asset; they may improve the efficiency or usefulness of an asset, and are not considered routine in nature. Capital expenditures are recorded as in increase to an asset account. Additions, betterments and extraordinary repairs are considered capital expenditures. b. Revenue expenditures -- expenditures related to the maintenance and operation of long-term asset necessary to keep a long-term asset in good operating condition. Revenue expenditures benefit only the current accounting period. They are typically considered routine in nature and tend to be smaller amounts than capital expenditures. Revenue expenditures are recorded as an increase in an expense account. 3. Depreciation Methods – need to know all 3 methods! a. Straight Line - results in equal depreciation each full year of usage of the asset Cost - residual value Estimated useful life = Depreciation per year This is the most popular method for financial accounting purposes.b. Production Method – results in equal depreciation each unit of usage during the assets life Cost - residual value Estimated useful units = Depreciation per unit Depreciation per unit * Units used in period = Depreciation c. Declining-balance method – results in higher depreciation in the early years of the assets’ life and lower depreciation each of the following years. (Remember -Year 1 use Cost – 0) 2 Years in assets life * (Cost - Accum. Deprec.) = Depreciation for the year 4. Disposals of Depreciable Assets – Steps to record the sale a. Record the depreciation expense for the current year up to the date of the disposal b. Compute the gain or loss on the sale: Net proceeds from the sale XXX Book value of the assets XXXGain or loss on sale XXX c. Record the sale: Cash Net proceeds Accum. depreciation Accum. deprec Loss or Gain on Sale $$$ or $$$ Asset Original Cost 5. Special rules for natural resources – a. Depletion – process used to allocate the cost of the natural resource over its useful life. Depletion expense computed like production depreciation. b. Assets used in relation to the extraction of natural resources should be depreciated. The depreciation method chosen should take into account the useful life of the asset and the usefulness of the asset after the natural resource has been recovered. 6. Special rules for intangible assets – a. Amortization – process used to allocate the cost of intangible assets that are considered to have a limited life. Amortization expense is computed like straight-line depreciation. b. Research and development costs – all research and development costs should be treated as revenue expenditures and charged to expense in the period in which they are incurred. c. Goodwill – is only recorded for accounting purposes when purchased. It should be treated as a separated item on the balance sheet and reviewed annually for impairment. 7. Impairment of assets – Each year, companies are required to determine the fair market value of their long-term assets to determine if the carrying value of the long-term assets exceeds the present value of the fair market value of the assets. (Fair market value is the amount for which the asset could be reasonably expect to be bought/sold for at that time.) If necessary, a journal entry is made to record a loss and to reduce the carrying value of the asset.CHAPTER 9 REVIEW I. VOCABULARY (Complete each of the following statement by filling in the appropriate word or words) 1. An expenditure for repairs, maintenance, or other services needed to maintain or operate plant assets is a(n) _____________________ expenditure. 2. An expenditure for the purchase or expansion of a long-term asset is a(n) _____________________ expenditure. 3. _________________ is the periodic allocation of the cost of a tangible long-term assets (other than land, natural resources, or intangible assets) over its estimated useful life. 4. The allocation of the cost of a natural resource to those periods in which the firm receives the resource's benefits is called ____________________, and the similar allocation of the cost of an intangible is called ____________________. 5. The _________________ method of depreciation applies a fixed percentage rate to an


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