CONCEPTUAL
Plant assets are set apart from other tangible assets
by two important features: use in operations and useful lives longer than
one period. Plant assets are recorded at cost when purchased.
Cost includes all normal and reasonable expenditures necessary to get the aset in
place and ready for its intended use. The cost of a lump-sum purchase
is allocated among its individual assets.
Partial-year depreciation
is often required because assets are bought and sold throughout
the year. Depreciation is revised when changes in
estimates such as salvage value and useful life occur. If the
useful life of a plant asset changes, for instance, the remaining cost to be depreciated is
spread over the remaining (revised) useful life of the asset.
Revenue expenditures expire
in the current period and are debited to expense accounts and matched
with current revenues. Ordinary repairs are an example of revenue
expenditures. Capital expenditures benefit future periods
and are debited to asset accounts. Examples of capital expenditures
are extraordinary repairs and betterments.
ANALYTICAL
Total asset turnover measures a company’s
ability to use its assets to generate sales. It is defined as
net sales divided by average total assets. While all companies desire
a high total asset turnover, it must be interpreted in comparison with those for
prior years and its competitors.
PROCEDURAL
Depreciation is the process of allocating to
expense the cost of a plant asset over the accounting periods
that benefit from its use. Depreciation does not measure the decline in a plant
asset’s market value or its physical deterioration. Three factors determine
depreciation: cost, salvage value, and useful life. Salvage value
is an estimate of the asset’s value at the end of
its benefit period. Useful (service) life is the length of time an asset
is productively used. The straight-line method divides cost less salvage value by
the asset’s useful life to determine depreciation expense per
period. The units-of-production method divides cost less salvage value
by the estimated number of units the asset will produce over its life to determine depreciation
per unit. The declining-balance method multiplies the asset’s
beginning-of-period book value by a factor that is often double the straight-line
rate.
When a plant asset is discarded or sold, its cost
and accumulated depreciation are removed from the accounts. Any cash
proceeds from discarding or selling an aset are recorded and
compared to the asset’s book value to determine gain or loss.
The cost of a natural resource is recorded in a noncurrent
asset account. Depletion of a natural resource is recorded by
allocating its cost to depletion expense using the units-of-production method.
Depletion is credited to an Accumulated Depletion account.
An intangible asset is recorded at the cost
incurred to purchase it. The cost of an intangible asset with a
definite useful life is allocated to expense using the
straight-line method, and is called amortization. Goodwill and
intangible assets with an indefinite useful life are not amortized—
they are annually tested for impairment. Intangible assets include
patents, copyrights, leaseholds, goodwill, and trademarks.
For an asset exchange with commercial substance,
a gain or loss is recorded based on the difference between
the book value of the asset given up and the market value of the asset
received. For an asset exchange without commercial substance, no gain or loss is recorded, and the
asset received is recorded based on the book value of the asset given up.
Guidance
Answers to Decision Maker and Decision Ethics
Controller
The president’s instructions may reflect an honest and reasonable prediction of the
future. Since the company is struggling
financially, the president may have concluded that the normal pattern of replacing assets
every three years cannot continue. Perhaps the strategy is to avoid costs of frequent replacements
and stretch use of equipment a few years longer until finansial conditions improve. However, if
you believe the president’s decision is unprincipled, you might confront the president with your opinion that it is
unethical to change the estimate to increase income. Another possibility is
to wait and see whether the auditor
will prohibit this change in estimate.
In either case, you should
insist that the statements be based on reasonable estimates.
Entrepreneur
Treating an expense as a capital expenditure means that reported expenses
will be lower and income higher in the
short run. This is so because a capital expenditure is not expensed immediately but is spread over
the asset’s useful life. Treating
an expense as a capital expenditure
also means that aset and
equity totals are reported at larger amounts in the short run. This continues until the asset
is fully depreciated. Your friend is probably trying to help, but the suggestion is misguided.
Only an expenditure
benefiting future periods is a capital expenditure.
Environmentalist
The paper manufacturer’s comparison of its total asset turnover with
food stores and auto dealers
is misdirected. These other industries’ turnovers are higher because their profit margins are lower (about 2%).
Profit margins for the paper industry
are usually 3% to 3.5%. You need to collect data from competitors in the paper
industry to show that a 1.9 total aset turnover is about the norm for this
industry. You might also want to collect
data on this company’s
revenues and expenses, along with compensation
data for its high-ranking officers and employees.
Comments
Post a Comment