Question

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Learning Objectives: CHAPTER 7

1. Measure and account for the cost of plant assets
2. Distinguish a capital expenditure from an immediate expense
3. Measure and record depreciation on plant assets
4. Analyze the effect of a plant asset disposal
5. Apply GAAP for natural resources and intangible assets
6. Explain the effect of an asset impairment on the financial statements
7. Analyze rate of return on assets
8. Analyze the cash flow impact of long-lived asset transactions

EXAMPLE OF WHAT I'M LOOKING FOR:

One thing I found challenging was the credits and debits concept from chapter two and matching them up, (common stock would be a cash debit and stock credit). Once I got it down it was one of those "why didn't it make sense to me sooner" moments but at the time I didn't understand and would switch things. How I approached the chapter was really to make sure I understood all the terms, ie notes payable, accounts receivable, etc. Being able to understand them without going back to the textbook made the process a bit faster and overall easier. Another thing was really taking advantage of the internet and that if there was something in the textbook I didn't understand, looking it up on Google and going through different websites and tutorials. While going through the problems I made sure to take as thorough notes as I could with information that I knew would help me moving forward, targeting the problems that were difficult for me. Being able to go back and read through something that was written in a way that made the most sense to me as an individual definitely proved helpful. I also Skyped a friend who is currently enrolled in a financial accounting class and we would work through problems together.

Answer 1

Measuring and Accounting the cost of a Plant asset:

The cost of a property or plant includes the purchase price and all the expenses incurred to bring the assets to it' s intended use.

For example: Cost of Land = Purchase Price + Commission + Stamp Duty, etc.

Accounting Entry = Plant / Land A/c (cost of land)   Dr. XXX

To Bank A/c XXX

Difference between Capital Expense and an immediate expense

1. Accounting: A capital expenditure is capitalised in the books of accounts whereas an immediate expense is in the nature of a revenue expense and is charged to profit and loss account.

2. Consumption: A capital expenditure becomes an asset and hence consumed over the useful life of the asset whereas a revenue expenditure is consumed within a very short period of time (less than a year).

3. Timing: Capital expenditure is charged to expense gradually via depreciation, and over a long period of time whereas a revenue expenditure is charged to expense in the period in which it is incurred.

Measure and record depreciation on plant assets

There are two most commonly used depreciation methods:

1. Straight Line Method: It is calculated by subtracting the salvage/scrap value (the price it can be sold at when it is no longer of use to the company) of an asset from the original purchase price and then dividing it by useful life of the asset. For example: Cost of a car = 10,00,000, Useful life of car = 10 years, salvage / scrap value at the end of 10^_th year = 50,000

. Depreciation = 10,00,000 - 50000 / 10 years

= 95,000

The depreciation will be 95,000.

2. Written Down Value Method (WDV Method): Because an asset typically lose the most value in earlier years, and experiences a slowing of depreciation later on. In WDV, a fixed rate of depreciation is charged on the book value of the assets over its useful life. For Example: Cost of car = Rs. 10,00,000, rate of depreciation = 10%.

Depreciation will be for 1st year = 10,00,000 * 10%

= Rs. 1,00,000

In 2nd year,  WDV = 10,00,000 - 1,00,000

= 9,00,000

Depreciation = 9,00,000 * 10%

= 90,000

Accounting entry for depreciation:

Depreciation A/c Dr. XXX

Asset A/c    XXX

Effects of Disposal of a Plant Asset

Asset disposal is the removal of a long-term asset (capital asset) from the company’s accounting records. An asset may be disposed of in following circumstances and their respective accounting entries in each circumstances:

• When an asset is fully depreciated.

Accounting Entry: Accumulated Depreciation A/c Dr. XXX

To Asset A/c XXX

• When an asset is sold either at a gain or loss.

Accounting Entry: Cash A/c Dr. XXX

Accumulated Depreciation A/c Dr. XXX

To Asset A/c XXX

To Gain on sale XXX

• When an asset is disposed of due to unforeseen circumstances (e.g. fire, theft).

Accounting entry: Cash A/c Dr. XXX

Accumulated Depreciation A/c Dr. XXX

Loss on sale A/c    Dr. XXX

To Asset A/c XXX

Application of GAAP on natural resources and intangible assets

GAAP are applied to natural resources in a same manner as it applies to any plant assets. When a natural resource is purchased, a journal entry is passed. If we purchased an ore mine for Rs. 6,50,000 cash , the entry would be:

Ore Mine A/c Dr. XXX

To Cash A/c XXX

For Intangible Assets

An intangible asset is one having no physical existence. It can be a property right, goodwill, trademark, etc.

An Intangible asset only appears on the balance sheet if it has been acquired. If Company XYZ purchases a trademark from Company PQR for an agreed amount of Rs. 1 Lacs, then Company XYZ would record a transaction for Rs. 1 Lacs in intangible assets that would appear under non-current assets in the balance sheet. The Rs. 1 Lac asset would then be written off over a number of years via amortization. Intangible assets like goodwill having indefinite life are not amortized. Rather, these assets are assessed each year for impairment, which is when the carrying value exceeds the asset's fair value.

Effect of Asset Impairment on Financial Statement

When an asset has a market price lower than it's carrying value in the balance sheet, the asset is called impaired asset. It is due to the sudden decline in the value of the asset.

Due to the recognition of impairment loss in the profit and loss a/c, the profitability of the entity decreases.

Consequently, a huge reduction in the value of the asset in the balance sheet.

It does not have any impact on the entity's cash flow statement as no cash transaction took place.

Analyzing the rate of return on assets

Return on asset refers to the ratio of net income derived by the entity to average total assets.

Return on assets = Net Income ÷ Average total assets  

Because the net income represents activities for a period of time and total assets is value on certain dates, therefore it is better to use average total assets instead of just total assets.

Higher the return on assets the better. A high return on assets means than the business was able to utilize its resources well in generating income.

Analyzing the cash flow impact of long-lived asset transactions

Long lived assets are simply non-current assets which a company holds for a period not less than one year and from which future economic benefits will accrue to the organisation.

When a long-lived asset is sold, it results in a cash inflow into the organisation and a cash outflow occurs in case a long-lived asset is purchased.