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Chapter 6’s Learning Objectives
• .
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Canadian Tire’s Balance Sheet
• .
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Learning Objective One
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Long-Lived Assets
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Long-Lived Assets – Expense Accounts
Asset Account Related Expense Account
(Balance Sheet) (Income Statement)
Tangible assets
Computers Depreciation
Buildings, Machinery, & Equipment Depreciation
• Tangible assets are resources with physical substance that are used in
the operations of a business and are not intended for sale to
customers.
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Tangible Assets – Expense Accounts
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Measuring the Acquisition Cost of PP&E
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Measuring the Acquisition Cost of Land
• Note that the cost of land does NOT include the cost of
fencing, paving, security systems, and lighting.
These are separate tangible assets—called land
improvements—and they are subject to depreciation.
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Measuring the Acquisition Cost of Land - Example
• A business signs a $300,000 note payable to purchase land for a
new production facility.
• It pays $10,000 in real estate commission, $8,000 in back property
tax, $5,000 for removal of an old building, a $1,000 survey fee, and
$260,000 to pave the parking lot.
• What is the cost of the land?
• Purchase price of land $300,000
• Add related costs:
• Real estate commission $10,000
• Back property tax 8,000
• Removal of buildings 5,000
• Survey fees 1,000 24,000
• Total cost of land $324,000
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Measuring the Acquisition Cost of Buildings
• The cost of constructing a building includes:
Architectural fees, building permits, and contractors’ charges
Materials, labor, and overhead
Interest on money borrowed to finance the construction
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Land Improvements and Leasehold Improvements
Land Improvements
• The cost for land improvement (e.g., parking lot pavement, driveways,
signs, fences) is recorded in a separate account entitled Land
Improvements.
Although these assets are located on the land, they are subject to
decay, and their cost should therefore be depreciated.
Leasehold Improvements
• Companies often lease equipment or property. Then, they customize
them for their special needs – leasehold improvements.
The cost of leasehold improvements should be capitalized and
depreciated over the term of the lease or the life of the asset,
whichever is shorter.
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Lump-Sum (Basket) Purchases of Assets
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Lump-Sum (Basket) Purchases of Assets - Example
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Learning Objective Two
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Depreciation
• Depreciation is the process of allocating long-lived assets’
acquisition cost to depreciation expense over their useful life due to
physical wear and tear and/or obsolescence as they are used to
generate revenue.
• Under the cost principle, the cost of PP&E is initially recorded on the balance
sheet at its original cost on the acquisition date, and then at its Book Value:
Acquisition Cost
Property and Equipment:
Aircraft $ 30,000,000
Less: Accumulated depreciation 1,500,000 $ 28,500,00
Carrying Amount
(Book Value)
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Depreciation Expense Calculation
• To calculate depreciation, we must know the following:
1. Cost
2. Estimated useful life
Length of service expected from using the asset.
May be expressed in years, units of output, kilometres, or some
other measure.
3. Estimated residual value (salvage or scrap value)
Expected cash value of an asset at the end of its useful life.
May be zero
• Useful life/salvage value are estimates depreciation expense is an
estimate.
• The estimated residual value is not depreciated because the company
expects to receive this amount from selling the asset at the end of its useful
life.
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Deprecation Expense Calculation – Depreciable Cost
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Straight-line (SL) Method
Depreciable Cost
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Straight-Line Method – Example
• At the beginning of the year, WestJet purchased ground equipment
for $62,500 cash.
• The equipment has an estimated useful life of 3 years, and an
estimated residual value of $2,500.
Number of
Step 2: Depreciation Depreciation
= × Units Produced
Expense Rate per Unit
for the Year
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Units of Production Method – Example
• At the beginning of the year, WestJet purchased ground equipment for
$62,500 cash.
• The equipment has a 100,000 kilometre useful life and an estimated
residual value of $2,500.
• Equipment was driven 30,000km in year 1, 50,000 km in year 2 , and
20,000 km in year 3.
• Step 1: Depreciation $62,500 – $2,500
= = $0.60 per km
Rate per unit 100,000 km
• Step 2: Depreciation
= $0.60 × 30,000 = $18,000
Expense (yr1)
Depreciation
= $0.60 × 50,000 = $30,000
Expense (yr2)
Depreciation
Expense (yr3)
= $0.60 × 20,000 = $12,000
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Units of Production Method – Example (cont’d)
Accumulated Carrying
Depreciation Depreciation Amount
Year Kilometres Expense Balance (net book value)
$ 62,500
1 30,000 $ 18,000 $ 18,000 44,500
2 50,000 30,000 48,000 14,500
3 20,000 12,000 60,000 2,500
100,000 $ 60,000
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Declining-Balance Method
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Declining-Balance Method – Double Diminishing
Balance Approach
The DDB computes depreciation as follows:
1. Straight-line depreciation (SL) rate: SL rate = (1 / Useful life in years)
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Declining-Balance Method – Double Diminishing
Balance Approach
All years except final year:
Note: this method ignores residual value until the asset’s last period.
Final year:
Annual
Beg. of Period - Residual Value
Depreciation =
Carrying Amount
Expense
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Double Declining-Balance Method – Example
• At the beginning of the year, WestJet purchased equipment for $62,500
cash.
• The equipment has an estimated useful life of 3 years and an estimated
residual value of $2,500.
• Calculate the depreciation expense for the first two years using the DDB
method?
Depreciation in Year 1:
Yr 1 2
Depreciation
expense
= $62,500 × ( 3 years ) = $41,667
Depreciation in Year 2:
Yr 2
2
Depreciation = ($62,500 – 41,667) ×
expense
( 3 years ) = $13,889
Beg. Carrying value 35
Double Declining-Balance Method – Example (cont’d)
Depreciation in Year 3 (Final year):
Yr 3 Depreciation $6,944 - $2,500 = $4,444
expense
=
Beg. CV Residual
Value
• Note: Under this method, we have to force depreciation expense in the final
year so that End of Period Carrying Amount = Residual value.
Depreciation Accumulated Carrying
Expense Depreciation Amount
Year (debit) Balance (net book value)
$ 62,500
1 $ 41,667 $ 41,667 20,833
2 13,889 55,556 6,944
3 4,444 60,000 2,500
$ 60,000
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Comparing Depreciation Methods
• The amount of the depreciation expense per year varies depending
on the depreciation method used.
• But the total depreciation expense over the life of the asset is the
same for all three methods. This is because over the life of the
asset, the cost is depreciated down to the residual value under all
three methods.
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Comparing Depreciation Methods
Double-diminishing-
Straight-line Units-of production
balance
Best for assets that Best for assets that
Best for assets that
generate revenue wear out based on
generate greater revenue
evenly. physical use.
earlier in useful life.
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Depreciation Patterns
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Mid-Chapter Summary Problem
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Learning Objective Three
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Depreciation for Partial Years
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Depreciation for Partial Years - Example
Full-year depreciation:
($500,000 – $80,000) ÷ 20 = $21,000
Partial-year depreciation:
$21,000 × 9/12 = $15,750
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Chang in Estimates – Useful Life and Residual
Value
After an asset is in use, managers may change the useful life and/or
residual value used to estimate the depreciation on the basis of
experience and new information. This is called a change in
accounting estimate.
In these cases, depreciation is revised as follows:
• Estimate the depreciation for an asset with cost of $40,000, useful life of
8 years with no residual value using the straight-line method.
• At the end of the second year, management believes that the asset will
remain useful for 10 more years (as opposed to the 6 years remaining).
$30,000 ÷ 10 = $3,000
(new depreciation per year)
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Changing Useful Life – Example 2
• WestJet purchased an aircraft for $60M. The aircraft is depreciated using
the straight-line method with a useful life of 20 years and residual value of
$3M.
• In year 5, WestJet changed the estimated useful life to 25 years and
lowered the residual value to $2.4M. Calculate depreciation expense for
the 5th year.
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Case 2: Disposing of an Asset Before Being Fully
Depreciated
Suppose M&M Meat Shops disposes of store fixtures that cost $4,000.
Assume accumulated depreciation up to date of disposal is $3,000, and
the carrying amount is $1,000. The asset is junked for no proceeds.
Record this disposal.
1. Update depreciation. Already recorded as per question.
2. Calculate carrying amount: Acquisition cost – Accumulated
depreciation = $4,000 - $3,000 = $1,000
3. Calculate gain or loss: The company incurs a loss on the disposal in
the amount of the asset’s net carrying amount ($1,000)
decrease in equity. [proceeds – CV = $0 - $1,000 = ($1,000)]
4. Record the disposal.
Accumulated depreciation – Store Fixtures (-XA) 3,000
Loss on the Disposal of Store Fixtures (+Loss -SE) 1,000
Store Fixtures (-A) 4,000
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Case 3: Selling PPE
If cash received
is greater than Debit GAIN
carrying amount
If cash received
is less than Credit LOSS
carrying amount
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JE to record sale of PPE
If loss on sale:
Date Accounts Debit Credit
Cash XXX
Accumulated depreciation – PPE (-XA) XXX
Loss on disposal of PPE (+Loss -SE) XXX
PPE (-A) XXX
If gain on sale:
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Case 3: Selling PPE – Example 1
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Case 3: Selling PPE – Example 1 (cont’d)
• Air Canada sold aircraft for $11,000,000 cash at the end of its 17th
year of use.
• The aircraft originally cost $30,000,000 with useful life of 25 years,
and was depreciated using the straight-line method with zero
residual value.
• Prepare the journal entry for the sale of this aircraft.
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Case 3: Selling PPE – Example 2 (cont’d)
1. Update depreciation: Aircraft was sold at the end of the 17th year
Full Depreciation
• Yr 17 depreciation expense (straight-line method):
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Selling PP&E – Example 2 (cont’d)
3. Calculate gain or loss on sale:
Gain = Proceeds – Carrying Amount (book value)
= $11M – $9.6M
= $1.4M
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Special Issues in Accounting for Property, Plant,
and Equipment
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Depreciation for Tax Purposes
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Depreciating Significant Components
• For example, Air Canada buys aircraft for use in its operations.
while the cabin and interior equipment are depreciated over the
lesser of 5 years or the remaining useful life of the aircraft.
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Impairment
• At each reporting date, a company should review its property, plant,
and equipment to see if an asset is impaired.
Impairment occurs when carrying amount > recoverable
amount
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Impairment (cont’d)
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Impairment Test - Example
Greater of
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Learning Objective Four
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Intangible Assets
• Intangible assets are long-lived assets with no physical form.
Intangibles are valuable because they carry special rights from
patents, copyrights, franchises, etc...
• Intangible assets fall into two categories:
1. Intangibles with finite lives
Should be amortized over the shorter of useful life or legal
life Straight-line method is often used but other methods
can also be used.
2. Intangibles with indefinite lives
Not amortized but are subject to impairment testing at each
reporting period.
Goodwill is the most prominent example of an intangible
asset with indefinite life.
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Intangible Assets – Expense Accounts
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Accounting for Specific Intangibles
1. patents,
2. copyrights,
5. goodwill.
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Intangible Assets: Patents
Patents are Granted by federal government to give the holder
exclusive right to produce and sell an invention
The invention may be a product (e.g., computer mouse) or a
process (e.g., IMAX’s projection process).
Life any other asset, a patent can be purchased
Amortize over the shorter of its useful life and legal life (20 years
in Canada)
If useful life is indefinite, amortize over the legal life of 20 years
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Intangible Assets: Patents - Example
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Trademarks and Trade Names
Shakespearecreative.com
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Franchises and Licenses
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Goodwill
• Goodwill is defined as the excess of the cost of purchasing another
company over the sum of the market values of the acquired company’s
net assets (assets minus liabilities).
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Goodwill – Example (cont’d)
• Now, assume that Canadian Tire performs an impairment test at the end of
the current year and recognizes a goodwill impairment loss of $0.3 million.
• This impairment is recorded as an expense on the income statement.
• Canadian Tire would record the write-down of goodwill as follows:
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Research and Development
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Learning Objective Five
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Return on Assets (ROA)
• ROA measures how much the entity earned for each dollar of
assets invested by both shareholders and creditors.
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Learning Objective Six
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Long-Lived Asset Transactions on the Cash Flow
Statement
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