FA2: Module 9 Tangible and intangible capital assets

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FA2 Module 9Tangible and intangible capital
assets

• Definitions
• Valuation at initial acquisition
• Intangibles
• Costs subsequent to acquisition
• Disposal of capital assets

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1. Definitions of capital assets

• Capital assets are identifiable assets that
• Are acquired for use in normal operations to
  produce goods and services or for rental
• Are acquired to be used on a continuing basis
• Are not intended for resale
• Capital assets are generally categorized as
• Tangible (property, plant and equipment)
• Intangible (goodwill, patents, etc.)

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Intangible assets vs. deferred charges

• A deferred charge is a kind of long-term prepaid
  expense, e. g., organization costs, the legal and
  administrative costs of setting up the
  corporation (or other organizational form). The
  future benefit belongs to the company only.
• An intangible asset (other than goodwill) is a
  specific, separable right that can be sold to an
  outsider (e. g., broadcast license, patent).

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2. Valuation at initial acquisition

• Capital assets are measured at historical cost,
  the cash or cash equivalent price of obtaining
  the asset and bringing it to the location and
  condition necessary for its intended use.
• Costs included in historical cost include all
  costs reasonable and necessary to prepare the
  asset for its intended use.
• Historical cost is a reliable measure of the fair
  value of the asset at the date of acquisition.

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2. Valuation at initial acquisition

• Basic examples
• Lump sum purchases
• Exchanges of non-cash assets
• Asset retirement obligations

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a. Basic examples Cost of land

• The cost of land includes
• The purchase cost of the land
• Legal and registration fees associated with
  closing the transaction
• Cost of preparing the land for intended use
  (landscaping, clearing, etc.)
• Assumption of taxes in arrears or other
  encumbrances
• Land improvements that have indefinite life

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a. Basics Buildings and equipment

• The cost of buildings include all costs related
  to acquisition (as with land) or construction
  (direct materials, direct labour, overhead).
  This can also include interest costs incurred
  during construction.
• The cost of equipment includes purchase price
  (less any discounts), taxes, tariffs, freight
  charges, assembly and installation costs, costs
  of conducting trial runs.
• Example A9-10

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b. Lump sum purchases (basket purchases)

• When several assets are purchased for a single
  lump sum, the purchase cost must be allocated to
  the individual assets acquired. This is
  typically done on the basis of relative fair
  market value of each asset as at the date of
  acquisition. Accountants might use
• Appraisal (for insurance or other purposes)
• Assessed valuation for property taxes

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Lump sum purchases Example

• The firm purchases land and a building for
  100,000. According to the city assessors, the
  lands appraised value is 60,000, and the
  buildings appraised value is 20,000.
• The entry to record the acquisition is

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c. Exchanges of non-cash assets

• Examples non-cash exchanges, transactions
  involving issue of shares
• The accounting treatment is fairly consistent in
  these cases. The cost of the asset acquired is
  taken to be the fair value of any assets given in
  exchange, unless the fair value of the asset
  acquired can be more reliably estimated.
• Exception Exchanges that do not have commercial
  substance

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Commercial substance

• A transaction has commercial substance when
• The configuration of cash flows of asset received
  differs from that of asset given up
• Present value of companys after-tax cash flows
  is significantly changed after the transaction
• If the transaction has no commercial substance,
  new asset is valued at book value of old asset,
  plus any cash paid/less any cash received.
• Example A9-6

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d. Asset retirement obligations

• Definition Legal obligation associated with the
  retirement of a tangible long-lived asset that
  the entity is required to settle as the result of
  enacted law, contract, etc.
• The present value of obligation is estimated (if
  it can be done with reasonable precision) and
  charged (debited) to cost of asset, with an
  offsetting credit to a liability account. Every
  year, interest (accretion) expense is computed
  on, and added to, the liability.
• Example A9-18

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3. Intangible capital assets

• Intangible assets are characterized by (1) a lack
  of physical existence and (2) high degree of
  uncertainty concerning the future benefits that
  they will generate for the firm.
• For many firms, their most important intangibles
  are not reported on the balance sheet.

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Intangible capital assets
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Valuation of intangibles

• Purchased intangible assets are recorded at
  historical cost, which includes purchase price,
  legal fees, etc.
• Amortization of intangibles
• Intangible assets are amortized over their useful
  lives. If useful life is considered to be
  indefinite, there is no amortization. Generally,
  they are amortized on a straight-line basis
  although other amortization methods could be
  used.
• Example A9-28

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Goodwill

• Goodwill is the difference between the market
  value of the entity as a going concern and the
  sum of the market values of the entitys
  identifiable net assets (assets liabilities).
• Goodwill arises from such things as
• -effective advertising
• -employee training
• -entitys reputation in the marketplace
• -strategic location, etc.

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Accounting for goodwill

• Internally generated goodwill is not capitalized
  because it is impossible to identify and measure
  with any reliability.
• Goodwill is recorded only when an entire business
  is purchased, and is recorded as the excess of
  the cost of the business over the fair value of
  net assets acquired (master valuation approach).
• Goodwill is not amortized, but is subject to
  impairment tests.
• Example A9-39

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4. Costs subsequent to acquisition

• The tendency is to expense costs incurred
  subsequent to acquisition unless these costs
  improve the asset in some way beyond original
  expectations.
• Expenditures that result from accident or neglect
  are considered losses.
• Maintenance and ordinary repairs keep the asset
  in normal working order and are expensed as
  incurred.

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4. Costs subsequent to acquisition

• Betterments enhance an asset by improving its
  productivity, reducing its operating costs and/or
  extending its useful life beyond original
  estimates. Betterments include
• Replacements involve replacing some major
  component of an asset with one of similar
  quality.
• Renewals involve large expenditures (e. g.,
  overhauls) that better the asset.

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Accounting for betterments

• Substitution Remove the cost of the old asset
  (or component) and its accumulated depreciation,
  recognizing any gain or loss on disposal, and
  capitalize cost of new asset. Sometimes book
  value of old asset is unavailable.
• Increase asset account Capitalize cost of
  betterment by debiting asset account.

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Other capitalizable post-acquisition costs

• Additions
• Extensions, enlargements or expansions of an
  existing asset (e. g., new wing added to
  building).
• Rearrangements
• Reinstallation, rerouting, moving or
  rearrangements of factory machinery. These can
  be capitalized if they have long-term effects on
  entity cash flows.
• Example A9-36

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5. Disposals of capital assets

• Two principal steps
• Record amortization expense up to date of
  disposal of asset, if applicable.
• Remove historical cost of asset and its
  associated depreciation. Record cash received.
  Gain or loss is difference between cash received
  and book value of asset at date of disposal.
• Example A9-30