AC 310 1st EditionFinal Exam Study Guide Days 26 - 29Days 26 - 29Chapter 11Impairment: when a significant decline of an asset’s benefits occurs- Recognizing a loss depends on if the asset will be used or sold in the futureIntangibles that are amortized (Definite Life)*Same approach taken as long-lived assets*Two step approach:1. Test for impairment: undiscounted sum of future cash flows must be lower than book value for an item to be impaired2. Book Value – Fair Value = Impairment LossPractice Problem2 (Day 29 Slides)Equipment purchased 8 years ago for 1,000,000Straight line method, 10% residual, 20 year lifeTest for impairment: decide remaining life = 7 yearsNet cash inflow: $80,000 year; Fair Value = $240,0001. Impairment?(1,000,000 – 100,000) = $45,000 annual depreciation20 yearsAccumulated Depreciation: $45,000 * 8 = 360,000Cost – Acc. Dep. = Book Value (1,000,000 – 360,000 = 640,000)2. Cash flows: $80,000 * 7 years = 560,000(BV: 640,000) > (FCF: 560,000) = impairment!3. Book Value – Fair Value = Loss640,000 – 240,000 = $400,000 Impairment LossJournal Entry:Dr Loss on Impairment 400,000Cr Acc. Dep. 400,000Would there still be impairment if fair value was $500,000?Yes: Only the loss would change. It would go from $400,000 to $140,000.Intangibles that are NOT amortized (Indefinite Life)Should be tested for impairment annually.*One step process:1. Compare book value to fair value (we expect cash flows to continue indefinitely)a. Divide yearly cash flows by discount rate to get fair valueb. If book value > fair value, then impairment exists.Recovery of an impairment loss is prohibited.GoodwillAcquired only with the purchase of a companyGoodwill is NOT amortized, so test yearly for impairment.Goodwill (in general) is Purchase price – fair value of net assets (always the residual amount)FV of net assets = assets – liabilitiesImpairment testing is a process:1. Estimate fair value for entire reporting (operating) unit2. Compare value of reporting unit with book valuea. If book value is greater, impairment loss is indicated3. Find Implied Fair Value of Goodwilla. Estimated fair value of reporting unit – net fair value of assets = Implied Goodwill**There may be other assets that are impaired, so the company would want to do impairment testing after gaining this knowledge.Assets Held for SaleFor assets held for sale, if Book Value Exceeds Fair Value minus cost to sell, an impairment loss isrecognized for the difference.Depreciation Methods:Straight-Line:(Cost – Residual) = Yearly depreciationUseful life*Gives an equal amount of depreciation for every yearSum of the Years’ Digits (Accelerated Method)*Multiplies the depreciable base by a fraction that declines each year*Asset provides greater benefits in the early years of its life than in later years.(Cost – Residual) * Depreciation Rate = Annual DepreciationDepreciation Rate: [n (n+1)] / 2Don’t change base number; only fractionFor five years: [5 (5+1)] / 2 = 15Year 1: 5/15 Year 2: 4/15 Year 3: 3/15 ETC, ETC.Double-Declining Balance:Book Value (1st year should equal cost) x RateRate: 2 / Useful Life*Multiply constant % by decreasing book value*Not uncommon for companies to change methods halfway through the year.Units of Production:(Cost – Residual) x Units for the year = Annual Depreciation Total Estimated Units*Never depreciate below residual value!ExpendituresRepairs / Maintenance: maintain a given level of benefitAdditions: acquire new major component to existing assetImprovements: replace major component of the assetRearrangements: restructure without making improvementsCost Allocation Processes (Used to help meet the matching principle requirements):Property Plant and Equipment DepreciationDr. Depreciation ExpenseCr. Accumulated DepreciationNatural Resources DepletionDepletion per ton = (Depletion base) / Estimated extractable tonsDr. Depletion ExpenseCr. Natural ResourceIntangible Assets AmortizationDr. Amortization ExpenseCr. Intangible AssetChange in Depreciation Method1. Solve for Depreciation to date2. Subtract out residual value3. Divide by remaining life= New annual depreciationChapter 10- Initial cost of PPE and intangible assets includes purchase price and all expenditures necessary to bring asset to its desired condition/location- Benefit now = expensed- Benefit over lifetime = capitalizedo Capitalize: record as asset and expense in future periodo If mistakenly capitalize instead of expense, overstate current income, assets and equity.- Note difference between land and land improvementso Life of land is indefiniteo Life of land improvements (parking lots, driveways, fences) is estimated- PPE provide benefits by being used; natural resources provide benefits by being consumed- Acquisition costs: for use of land- Exploration/Development Costs: before production begins- Restoration Costs: during/at end of extractionIntangible Assets: no physical substance; exclusive rights*Amortize cost (unless indefinite life)1. Patent: right to manufacture/use a product (20 Years)2. Copyright: protection to creator of published work (Life of Creator + 70 Years)3. Trademark: right to display slogan/symbola. 10 Yearsb. Life can be indefinite because renewable4. Franchise: agreement for one to use franchisor’s trademark and product (fast food chains)5. Goodwill: not separable from companya. Unique features/ “magic”b. Residual asset: amount left after other assets are identified and valuedc. Total fair value – fair value of net assets = Goodwilld. DO NOT AMORTIZE GOODWILLLump Sum PurchasesStep One: Add all individual fair values of assetsStep Two: Take % of individual fair value / total fair value sumStep Three: % x Purchase PriceStep Four: Journal EntryDr. (All individual assets)Dr. “………………………”Dr. “……………………...”Cr. Cash (Purchase Price)Interest Capitalization- Only capitalize interest incurred during construction period- Begins with construction- Only capitalize amount of interest that could have been avoided if construction had not been undertaken- Average accumulated expenditures: approximates the average debt necessary for constructionSteps:1. Find Maximum Interest Capitalizationa. Take all debt & rates and find total possible interest available2. Find Weighted Average Rate on other debt (debt that’s not related to project)a. Interest / amount of loans = weighted average rate3. Weighted average accumulated expendituresa. Fraction x