Long Term Assets Fixed Investment and Intangible Chapter 7 A200 Survey of Accounting University of Tennessee Fall 2015 2 Ch 7 Business Expenditures Costs All expenditures are recorded as either Asset on Balance Sheet Expense on Income Statement Capitalize the cost as an asset on the balance sheet if the item will be used in the future to generate revenue Expense the cost on the income statement if the item is used up in the current period to help generate revenue Current assets Long term Assets Fixed PPE Investment Intangible 3 Capitalize costs vs Expense costs Why does it matter The 2001 fraud at WorldCom ultimately topped 11 billion and led to the country s biggest bankruptcy filing in July 2002 Nearly 17 000 employees lost their jobs as a result of the scheme to bury expenses and inflate revenue The accounting fraud at WorldCom amounted to a decision by its chief financial officer Scot Sullivan to categorize as long term investments long term assets money paid to local phone companies to complete phone calls which should have been expenses All told Sullivan capitalized costs from 540 million to 797 million per quarter over five quarters Sullivan and the former controller David Myers were fired for claiming 3 8 billion in regular expenses as capital investments in 2001 Charged with securities fraud conspiracy and other charges they face 65 years in prison A federal judge sentenced former WorldCom Inc chief executive Bernard J Ebbers to 25 years behind bars for his role in the nation s largest accounting fraud the harshest prison term yet to flow from corporate scandals that rocked the stock market in 1999 2002 Forbes com Cheatingculture com 4 Ch 7 Long Term Assets Fixed Investment and Intangible Fixed PPE Investment Intangible Physical substance Yes Held for resale No Used by business for productive purposes Used by business to generate operating revenue Yes No Yes Yes Yes No No No Yes No Yes Ch 7 Accounting for Long Term Assets 5 Transaction 1 Long Corporation began business on 1 01 15 It purchased for cash a plot of land to be used for a business building The land cost 85 000 It also used 50 000 of cash to purchase an investment in the stock of Wind Corporation and 40 000 for a business patent STATEMENT OF CASH FLOWS BALANCE SHEET Assets 175 000 Cash out Investing INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS Cash Investment in Wind Corp stock Land Patent 175 000 50 000 85 000 40 000 Liabilities Equity Land is a tangible fixed asset not depreciable Patent is an intangible asset we will not study amortization of intangibles Investing in the stock of another corporation creates an investment asset not depreciable Ch 7 Accounting for Fixed Assets At date of acquisition 1 What is the asset s cost Over the asset s useful life 2 How do we classify subsequent expenditures related to the asset 3 What is the annual depreciation expense on the asset using straight line method or double declining balance method 4 What is the accumulated depreciation on the asset at any point in time 5 What is the book value of the asset at any point in time At date of disposition 6 What is the gain or loss when we dispose of the asset 6 7 Ch 7 Accounting for Fixed Assets Capitalized Asset Cost All expenditures necessary to acquire an asset and put it to its intended use see pg 254 of textbook for examples of costs that are properly capitalized Necessary Do not capitalize as assets the costs of repairing damage fines etc These costs are expensed on the income statement Example Long Corporation made the following expenditures to acquire a piece of equipment and put it to use Purchase price of equipment 315 400 Sales tax on purchase 2 500 Freight costs 1 700 Insurance 4 100 Installation and testing 800 Repair of damage incurred during installation Cost of Equipment 324 500 1 000 8 Ch 7 Accounting for Fixed Assets Transaction 2 Long Corporation paid the freight and damage costs with cash and gave a note payable for the rest STATEMENT OF CASH FLOWS BALANCE SHEET Assets 2 700 Cash out Investing INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS Cash Equipment 2 700 324 500 Liabilities Note Payable 322 800 Equity Retained Earnings 1 000 1 000 Repairs Expense 9 Accounting for Fixed Assets Expenditures made subsequent to asset acquisition Capital Expenditures Capitalize on the balance sheet if 1 The cost improves the asset increase Asset cost Revenue Expenditures Expense on the income statement if 1 The cost maintains the asset increase Maintenance expense 2 The cost extends the asset s 2 The cost is an ordinary repair useful life an extraordinary repair increase Repairs expense decrease Accumulated Depreciation on the asset 10 Accounting for Fixed Assets Transaction 3 After acquisition Long Corporation made the following expenditures related to the equipment regularly scheduled maintenance 2 000 added a new element to the equipment 5 500 Long paid for both expenditures with cash STATEMENT OF CASH FLOWS INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Cash Equipment 5 500 Cash out Investing 5 500 5 500 2 000 Cash out Operating 2 000 Liabilities Note Payable Equity Retained Earnings 2 000 2 000 Maint Expense 11 Depreciation of Fixed Assets Depreciation 1 Periodic expensing of fixed asset cost other than cost of land reflecting use of the asset during the period Caused by physical depreciation wear and tear on the asset Caused by functional depreciation obsolescence of the asset 2 Does not reflect decline in market value of the asset 3 Does not use cash Periodic asset depreciation is recorded as increase Depreciation Expense increase Accumulated Depreciation on the asset 12 Depreciation of Fixed Assets Depreciation terms Cost Useful Life estimated number of years business will use the fixed asset Residual Value estimated amount business expects to receive at the end of the useful life when it disposes of the fixed asset Depreciable Cost Cost Residual Value Depreciation Expense Accumulated Depreciation Book Value Cost Accumulated Depreciation 13 Depreciation of Fixed Assets Straight line depreciation S L Transfers to expense an equal amount of fixed asset cost in each year of use expensing all the depreciable cost over the useful life Annual depreciation expense Depreciable cost x 1 Useful Life Double declining balance depreciation DDB Transfers to expense all the depreciable cost over the useful life but expenses more than S L in early years and less than S L in later years Annual