ACCT 209 1nd Edition Lecture 8 Outline of Last Lecture I The Accounting Cycle II Closing Entries III Financial Statements IV Using the Financial Statements V Types of companies VI Inventory systems VII Purchasing Inventory a Example VIII Calculating Costs of goods sold a Example IX Inventory Cost Flow methods a Example of Inventory Cost Flow b Comparing inventory Cost Flow Methods X Other Inventory Issues a Example of Inventory Errors XI Estimating ending inventory Outline of Current Lecture XII Long lived assets a Acquisition I Example b Use over multiple years I Methods II Example Current Lecture Chapter 9 LONG TERM FIXED ASSETS Long lived assets o major assets acquired for use in the continuing operations of a business operating assets o help produce revenues over many periods o includes 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 1 Property Plant and Equipment includes land buildings equipment furniture 2 Natural Resources includes oil deposits coal deposits timber 3 Intangible Assets includes copyrights patents trademarks trade names franchises goodwill 4 Other Assets 5 Investments Accounting for Long term assets includes three issues 1 Acquisition 2 Use over multiple years 3 Disposal PROPERTY PLANT AND EQUIPMENT Acquisition Cost principle acquisition cost includes all normal and reasonable costs incurred to acquire asset and prepare it for intended use Land includes costs such as title fees real estate commissions survey fees attorney and legal fees costs to prepare land for use such as leveling tearing down old structures less any salvage recovered delinquent taxes paid Taxes from a prior period Land is NOT depreciated since it does not have finite life However land improvements such as paving fencing outdoor lighting etc can be depreciated Note Land cannot be expensed but improvements can be expensed Buildings if purchased includes purchase price taxes costs to repair and repurpose prior to occupancy if constructed costs includes architects and engineers fees construction costs and insurance and interest paid to finance during construction Note Buy building and finance purchase Interest not included Equipment includes taxes transportation costs installation costs including testing repairs needed to prepare used equipment for use assembly costs permits Unnecessary costs that do not increase the asset s usefulness such as damage during delivery or installation vandalism fines for not obtaining required permits etc are NOT included in the cost but are expensed as incurred Example Asset purchase 1 Montana Manufacturing Company purchased land for 60 000 Back taxes paid by Montana were 1 200 costs to clear and grade the land were 1 500 fencing costs were 2 500 and lighting costs were 500 Clearing the land included razing an old shed materials salvaged from the shed were later sold for 300 What amount should be recorded as the cost of the land Note back taxes are unpaid taxes from prior period 60 000 1 200 1 500 300 62 400 Land 62 000 1 200 1 500 300 Both are equivalent 2 On August 20 Montana Manufacturing Company purchased a new drill press The new equipment had an invoice price of 15 000 The seller offered a cash discount of 300 Other costs associated with the purchase of the press included sales tax of 375 freight charges of 1 000 and installation and connection costs of 500 Montana also paid 240 in insurance for the first six months of the equipment s use Determine the amount to be reported as the cost of the equipment Note The first 6 months of insurance for equipment use is not an asset cost It is a usage cost 15 000 300 375 1 000 500 16 575 3 Montana Manufacturing purchased a building its surrounding land and some equipment in a lump sum purchase AKA basket purchase for 230 000 An appraisal showed the following values for each item Building Land Equipment 180 000 180 360 50 126 000 126 360 35 54 000 54 360 15 360 000 How should Montana record the acquisition of these assets Building 5 230 000 Land 35 230 000 Equipment 15 230 000 115 000 80 500 34 500 230 000 Assets Cash 230 000 Land 80 500 Building 115 000 Equipment 34 500 How to record Long term Assets and Accumulated depreciation Assets Cash Buy Adj Entry LT Asset L SE Accum Depr 100 100 25 75 Book Value or carrying Value Cost AD 25 Recording Use over productive life matching principle cost of asset should be matched against revenue that it helps generate if unable to match cost directly against revenue then expense in period incurred or expense in a rational and systematic way Depreciation is a process of cost allocation That is the purpose of depreciation is to expense the cost of the asset over the years the asset is used to help generate revenues Depreciation is NOT an attempt to show the asset s current market value Effect of recording depreciation on financial statements Increase Depreciation Expense Lower net Income Increase Accumulated Depreciation Lower Total assets Note Accumulated Depreciation is a contra asset Depreciation expense is based cost of asset and two estimates Useful life cost must be allocated over the periods benefiting from use of asset Salvage value or residual value the amount expected to be obtained at disposal of asset Methods of calculating depreciation expense 1 Straight line method allocates expense evenly over useful life Expense each year Cost salvage value Useful Life 2 Units of activity method also called units of production units of activity expense related to actual usage rather than time life of asset expressed in terms of number of units asset will produce Expense cost salvage value useful life in units X units produced in current period Asset cannot be depreciated to an amount less than its expected salvage value 3 Accelerated method i e double declining balance method records more expense in early years of use Expense 2 life x book value Since book value changes each year expense changes each year And again asset cannot be depreciated to an amount less than expected salvage value 4 MACRS and ACRS method usually required by IRS for tax purposes Example Depreciation methods A truck costing 16 000 was purchased on January 2 2002 At the time of the purchase the truck s estimated salvage value was 1 000 and its estimated useful life was 5 years 100 000 miles 1 2 Prepare a depreciation schedule see below for the life of the truck showing the depreciation expense accumulated