ACCT3032-Chapter11-Exam Review ACCT 3032
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This 21 page Class Notes was uploaded by Doris.Shaw on Sunday September 18, 2016. The Class Notes belongs to ACCT 3032 at University of Cincinnati taught by Professor Bruns in Fall 2016. Since its upload, it has received 19 views. For similar materials see Intermediate_Accounting II in Accounting (ACCT) at University of Cincinnati.
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Date Created: 09/18/16
ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: ● There are a few conceptual questions pertaining to depreciation, amortization and impairment charges and the impact on the various financial statements or elements as well as steps in calculating whether impairment has occurred.These do not require calculations. 1. Conceptual Questions: Depreciation, Amortization and Impairment Charges Difference: ➔ Depreciation→ used for the cost allocation of tangible longlived assets ➔ Depletion→ used for the allocation of natural resources (coal & oil) ➔ Amortization→ used for the allocation of intangible assets 1.1 Depreciation To accountants, it is a means of cost allocation rather than a matter of valuation. Definition: The accounting process of allocating the cost of tangible assets to an expense in a systematic and rational manner to those periods expected to benefit from the use of the asset. Apply to: Tangible Assets Function: 1) the matching principle is met. Costs of using the asset ← ∞ the revenues the asset produces 2) Uncertainty in measuring the fair market value of an asset There is a tremendous amount of subjectivity involved in the determination of fair market value of an asset. This determination is tenuous and extremely difficult. The cost to value every asset at fair market value every year would be prohibitive. FMV: The agreed upon price between a willing buyer and a willing seller in an arms length transaction where neither party is under pressure to act. 1.2 Amortization Definition: The systematic method of writing off the cost of an intangible asset Apply to: Intangible assets having a limited or finite life; with an indefinite life are NOT. ❏ Limited or definite life intangibles have an identifiable life → Be amortized over the useful life * Means: the period of time that the asset is expected to be useful to the organization can reasonably be determined. Factors in determining the useful life of an intangible asset: 1 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: Expected use of the asset by the entity. The expected useful life of another asset or a group of assets Legal, regulatory or contractual provisions Any legal, regulatory or contractual provisions that enable renewal or extension of the asset’s legal or contractual life without substantial cost. Effects of obsolescence, demand, competition, and other economic factors. The level of maintenance expenditures required to obtain the expected future cash flows from the asset. ❏ Indefinite Life Intangibles If no legal, regulatory, contractual or other factor limits the life of an intangible asset then the asset is considered an indefinite life intangible asset. → Should NOT be amortized. Should be reviewed for impairment annually A loss recorded in the event that impairment has occurred. Because indefinite life intangible assets are NOT amortized their book value equals historical cost unless an impairment has been recorded. ★ Determining Indefinite Versus Definite Life Intangibles clearly have a definite life due to some regulatory or legal life. 2 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: ● How to calculate the net book value (carrying value, adjusted basis, book value) of the asset or net tax value of the asset. 2. The Depreciation Process: 2.1 Allocation Base The cost of an asset includes the purchase price plus all costs incurred to get the asset ready for its intended use, including insurance to ship the asset to its final destination, sales taxes and other related costs. Salvage value/residual value: the estimated amount that will be received at the time the asset is sold or removed from service. Many companies simply assume a residual value of zero and usually do not disclose estimated residual values. 2.2 Service Life ≈physical life Assets are retired. 1) physical factors such as wear and tear, casualty or decay make it difficult for the asset to perform indefinitely. 2) economic factors such as obsolescence, inadequacy or supersession will be reason to retire an asset. In many cases, the primary basis for estimating the useful life of an asset is the enterprise’s past experience with the same or similar assets. ● How to calculate depreciation using the straightline and MACRS methods. The MACRS tables will be attached to the exam. 2.3 Allocation Methods (most commonly used) 1) Straightline; 2) Declining Basis (MACRS)(Modified Accelerated Cost Recovery System) MACRSonly applies to property, plant and equipment, not to intangibles or natural resources ❏ Straightline Method ➔ Depreciation of tangible assets Considers depreciation and amortization as a function of time versus a function of usage. 3 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: Partial periods must be calculated. For tangible assets the charge is made to depreciation expense on a yearly basis until the full depreciable basis (allocation base) is expensed or until the asset is sold, whichever comes first. The entry: Impact: Income goes down; Contra assets → decrease the assets. net book value, book value, adjusted basis, basis, and carrying value are used synonymously Two differences at: Depreciation; and gain & loss CALCULATE NET BOOK VALUE AT ANY POINT IN AN ASSETS LIFE IF YOU KNOW HISTORICAL COST AND THE DEPRECIATION LIFE AND METHOD. ➔ Amortization of a Limited Life Intangible should reflect the manner in which the asset is utilized or consumed Most companies use the straightline method because it is simple and the amortization expense is consistent from period to period. No one method is required by GAAP. 4 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: Once the amortization expense amount has been calculated the entry to record the expense Impact: Net Income goes down; Contra assets → decrease the assets. Amortization continues until the asset’s historical cost is fully recovered or the asset is sold (or disposed of) Book value/carrying value/net book value/adjusted basis= Historical cost accumulated amortization Limited life intangibles should be reviewed for impairment continually: FMV of the intangible < Book Value/ carrying value→ an impairment loss should be recognized. ❏ Declining balance methods Using a depreciation rate expressed as a percentage the constant declining balance rate is applied to a successively lower book value that results in lower depreciation charges each year. This process continues until the asset is fully depreciated or sold, whichever comes first. the straightline method for book purposes → easier and produces a larger book income MACRS for tax purposes→ MACRS allows for the largest depreciation deduction by law for tax purposes. Companies that want to avoid the record keeping requirements for two methods will often use MACRS for book and tax. Function: MACRS was adopted to simplify depreciation calculations and maintain some consistency among companies. MACRS provides for the following depreciation methods and conventions depending on the class life of the asset: 5 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: ➔ HalfYear Convention requires that a halfyear’s worth of depreciation be allowable in the year of acquisition and the year of disposition regardless of the purchase date of the asset. one year will be added onto the asset’s useful life for the length of time the asset will be depreciated. 6 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: 3. Impairments ★ Why Record an Impairment? A substantial loss in value in a revenue producing asset results in a theoretical loss in revenue. Must recognize this loss in income and reduce the net book value of the asset on the balance sheet To reflect the loss in value and to state the asset closer to its net realizable value. This approach is conservative. ● How to calculate (including all steps) and record impairment losses on tangible and intangible assets with definite lives 3.1 Impairments of PPE AND Finite Intangible Assets An impairment of an asset occurs when the carrying value of the asset is not recoverable and therefore a writeoff is needed. The following steps should be taken in a possible impairment situation: (2) A recoverability test requires an estimate of the undiscounted future net cash flows expected from the use of the asset and its eventual disposition. (3) If the recoverability test indicates impairment the actual loss must be computed as follow: The fair value of the asset is determined by its market value if one exists. If None→ the present value of expected future net cash flows should be used. The company’s market rate of interest should be used in determine the present value of expected future cash flows. 7 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: (4) The entry to record the loss is fairly straightforward: Impact: Net Income goes down; Contra assets → Assets goes down. ● How to calculate (including all steps) and record impairment losses on intangible assets with indefinite lives 3.2 Impairment of Indefinite Life Assets – Other Than Goodwill A one step process. Most indefinite life intangibles would pass the recoverability test because the expected future cash flow would go on indefinitely. For indefinite life assets only the fair market value test is performed. If the fair market value is less than the carrying value then an impairment loss should be recorded for the difference effectively reducing the asset down to fair market value. A review of indefinite life intangible assets should be done on an annual basis to determine if impairment exists. The impairment loss is determined: The entry is: Impact: Net Income goes down; Assets goes down. 8 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: ● How to calculate (including all steps) and record the impairment of goodwill. 3.3 Amortization of Goodwill ← FASB has changed Past: Goodwill was written off over a period not to exceed 40 years using the straightline method. Now: Goodwill will be reviewed for a loss in value and if such loss occurs and impairment charge will result in the period the impairment is determined. 3.3.1 Impairment of Goodwill A twostep process: ❏ Step 1: Must be determined if overall goodwill still exists. To do so the fair market value of the reporting unit should be compared to the carrying value of all net assets including goodwill. (1) If the fair value of the reporting unit is greater than the net book value of all assets including goodwill then no impairment has occurred: (2) If it is determined that NO impairment exists then no accounting entries are required. ❏ Step 2: Determine the implied goodwill at the date of testing: (1) If it is determined that there IS an impairment then the fair market value (implied fair market value) of the goodwill is compared to it’s carrying value as followed to determine the impairment loss 9 ACCT 3032 INTERMED ACCT II Content of the Chapter 11 Exam: Know the following: (2) If an impairment loss has occurred it must be recognized in the accounts 4. Presentation of Fixed Assets 1. On BS: 2. On IS: 3. In the Notes: 10