ACG2021

Complete test 2 study guide   

chapter 5

acquisitions: purchase and use of business assets

Acquisition of long-term assets: the business process (LO 1)

I.                     Long-term assets (fixed assets) are assets that will be used for more than one accounting period (or typically stated, will last for greater than one year).

 

a.       Tangible assets (can be seen and touched)

                                                   i.      Land

                                                 ii.      Factory buildings

                                                iii.      Machines

                                               iv.      Computers

                                                 v.      Natural resources (minerals or timber)

 

b.      Intangible assets (not visible or touchable)

                                                   i.      Copyrights

                                                 ii.      Patents

                                                iii.      Trademarks

                                               iv.      Franchises

                                                 v.      Goodwill (The difference between what you pay and actual worth when you purchase something for more than its book value)

Allocating the cost of long-term assets (LO 2)

 

I.                     Capitalizing a cost - means to record it on the balance sheet as an asset

 

II.                   The cost is later recognized as an expense in the periods in which the asset is used

 

a.       Same as prepaid rent, prepaid insurance, etc.

 

III.                Tangible Assets

 

a.       Depreciation is a systematic, rational allocation process to recognize the expense of long-term assets over the periods in which they are used

b.      Depreciation expense is recorded as part of the adjusting process, before the financial statements are prepared

c.       The adjustment decreases the amount of the asset in the accounting records via accumulated depreciation (a contra-asset) and decreases owners’ equity via depreciation expense

d.      Also referred to as “writing off” or “expensing” the cost of the asset

 

IV.                Intangible Assets

 

a.       Amortization refers to writing off an intangible asset (patent)

 

 

V.                  Natural Resources

 

a.       Depletion refers to writing off a natural resource (timber)

b.      Depreciation refers to writing off a tangible asset other than a natural resource (equipment)

 

 

 

 

 

 

Example 1: (depletion example)

 

  SML International owns an oil field with an estimated 10,000,000 barrels of oil in it. The oil field was acquired at a cost of $25,000,000. In 2003, 1,000,000 barrels were produced and in 2004 1,750,000 barrels were produced.

 

How much depletion expense should be recorded in 2003 and 2004 based on this information?

            Step 1:             Total Cost                     = Cost per Unit

                          Total # Expected Units

           

                        $25,000,000      = $2.50 per barrel

                        10,000,000 barrels

            Step 2: Cost Per Unit x # of units extracted

           

                        (2003) $2.50 x 1,000,000 = $2,500,000 depletion expense

                                (2004) $2.50 x 1,750,000 = $4,375,000 depletion expense

Acquisition costs (LO 1&2)

I.                     Historical cost principle (Chapter 2) is used to record an asset at the amount paid for it

 

II.                   Equipment purchase includes

a.       Purchase cost

b.      Freight-in (cost to have the equipment delivered)

c.       Insurance while in transit

d.      Installation costs, including test runs

 

III.                  Building construction/acquisition includes

a.       Architect’s or contractor’s fees

b.      Construction costs

c.       Costs of renovating or repairing the building

 

IV.                When a cost is incurred there are two possible accounting treatments

a.       Capitalize

                                                   i.      Cost is recorded as an asset (becomes part of depreciable amount)

                                                 ii.      Expense recognition is deferred

b.      Expense

                                                   i.      Cost is recorded as an expense

                                                 ii.      Expense is recognized immediately

 

V.                  Special treatment for land

a.       Land retains its usefulness and is not used up to produce revenue

b.      Land cost is not amortized or depreciated

 

Example 2:

 

        David Justice Company incurred the following expenditures related to the purchase and use of a new building that will be used as the growing company’s corporate headquarters and will be located in Reno, Nevada.

 

Expenditure	Amount
Building materials (wood & brick)	$560,000
Labor & labor related costs	$256,000
Architect’s fee	$78,000
Rental of equipment used in the construction	$80,000
Annual utilities costs to operate the building (In use on Feb 8)	$52,000
Cost to fix a broken window (June 3)	$90
Cost to clean a stained rug	$230
Annual janitorial costs to keep the building clean	$3,900

 

 

Determine the total costs that should be capitalized into the machine account.

 

Includes everything that was used to complete the construction of the new building.  Once construction is complete, all other expenses are simply expenses and should not be capitalized into the machine account.

 

         Building Materials                      $560,000

         Labor costs                              $256,000

         Architect’s fee               $78,000

         Rental Equipment                      $80,000

                                                         $974,000

 

VI.                Basket purchase allocation

a.       Buying two assets for a single price (land and building)

b.      Need to calculate separate cost for each asset

c.       Relative fair market value method