Long Term Operating Assets

Key Things To Know

 

When money is spent, you must either capitalize or expense the amount:

 

Capitalize means “call it an asset” and report it on the balance sheet.
Long term assets are expensed over time used

An expenditure expected to benefit future periods is capitalized

Expense:
Future benefit is not probable
Used to produce revenue this period only

General rules:

Capitalize all costs necessary to get the asset to the point it can be used to
produce revenues (incurred before you begin using it to produce revenues)

Capitalize cost after asset is in use (subsequent expenditure):

1) Extends the useful life
2) Increase productivity or increase the quality after you are using the asset

Expense
Routine repairs and maintenance (costs that have to be repeated)

All costs that benefit this period only (no probable future benefit)
(includes advertising and research and development)

Property, Plant, Equipment: Assets used long term to produce revenues

Add to the purchase price and include in the cost of the asset

Land:
Sales tax, title search and transfer cost, attorney fees, real estate commission,
remove old buildings from land, bulldozing, survey fees, back taxes

Land Improvements:
Enhancements to land that must be replaced or repaired
example: parking lots, driveways, fences, permanent landscaping, sprinkler systems

Buildings:
Sales tax, title search and transfer costs, real estate commission, attorney fees, remodel before using, architect fees, back taxes

Equipment
Sales tax, delivery costs, freight-in, shipping, installation, training

The cost of an asset does not include damages or fines that could have been avoided

Lump Sum Purchase:
Purchase several assets for one purchase price

Record separately each type of asset that was purchased because they will be used over different useful lives and expensed over different period of time

Allocate cost to each asset type based on proportionate fair market value

Self-Constructed Assets: The company builds the asset rather than purchasing

Cost of the Asset = Materials+ Direct Labor + Allocated portion of overhead + interest

Overhead allocation:

Full-cost approach
All overhead costs are allocated both to production and construction based on a chosen cost driver.

Interest Costs: the cost of financing while the asset is being constructed

1) only capitalize interest incurred on assets that are constructed as identifiable projects

2) the period that interest is capitalized begins with the first expenditure and ends when the asset is placed into service to produce revenues

3) the company must have outstanding debt and actually incur interest expense for interest expense to be capitalized; however, the borrowing does not have to be specifically for the construction of the asset

Computing Interest to be capitalized:

1) Determine average accumulated expenditures during the period

2) Compute a weighted average interest rate for borrowings that were not specifically borrowed for the construction

3) $ Amount spent x time (months /12) x rate (%) = amount capitalized

Capitalized interest may not be higher than interest actually incurred

Exchange of Assets:

Assets acquired in transactions that do not involve cash are valued at the fair
market value of the assets given up or received, whichever is more clearly evident and more reliable

1) Remove the asset given up at cost and the associated accumulated depreciation

2) Record the asset received at the fair market value of the asset received or given up, whichever is more readily determinable, plus cash paid or less cash received

3) Record a gain or loss to balance the journal entry

When neither fair market value is not determinable the asset received is recorded at the book value of what is given up and there is no gain or loss on the exchange

Research and Development costs:

All research and development costs with no probably economic benefit is expensed in the period incurred

General Rules:
Expense all costs before the start of commercial production
Capitalize all costs after the start of commercial production

Expense:
Research aimed at discovering new knowledge
Research searching for new applications
Design, construction, testing before production
Modifying the formulation of a design (no product yet)

Capitalize:
Engineering in early phase of production
All costs incurred during production (overhead)
Ongoing efforts to improve an already existing product
Adapting an existing product to a specific customer need

Research & Development performed by others:
Treat as a long-term contract and capitalize costs until the project is completed and then expense as cost of services provided

Start-up costs of a new product or service: expense in the period incurred

Software Development Costs:

Technological feasibility: The product can be produced, works, and a market exists that gives a profit

Expense: All costs incurred before technological feasibility
Capitalize: All costs incurred after technological feasibility, amortize

Costs incurred after technological feasibility and before the product is produced are capitalized as an intangible asset – “software costs”

Purchased Research and Development in an acquisition:

Capitalize until the probable future economic benefit can be estimated.
Test for impairment.

Intangible Assets:
No physical substance, grants an exclusive right to the owner

Capitalize: All costs paid outside the company
Purchase price, legal fees, filing fees

Expense cost incurred internally (salaries) and all internal development costs

Some intangible assets have indefinite life; others have a definite life:
Definite life means there is a set amount of years the benefit will occur

Patents – 20-year life
Trademarks – Indefinite life (renewable 10-year periods)
Copyrights – life of creator + 70 years (most companies use 50 years)
Franchises – life is the amount of time purchased under the contract
Legal or contractual rights purchased in an acquisition: contract life

Goodwill: Occurs only when a company purchases all of another company

Internally developed goodwill is not recorded
Goodwill has an indefinite life, is tested for impairment, and is not expensed periodically.

Natural Resources:
Benefits are derived from sale or physical consumption
Examples: timber, mineral deposits, precious metals, oil and gas deposits

Associated costs recorded as part of the asset cost are geographic surveys, exploration costs, and restoration costs

Capitalize as a natural resource (report as part of PPE):

1) acquisition costs – amounts paid to acquire rights to the asset
2) exploration costs – drilling & excavation costs
3) development costs – before production begins
4) production costs – extract the resources
5) restoration costs – after production

As production occurs:

Depletion Expense
             Asset

or

Inventory
           Asset
Cost of goods sold
           Inventory