Asset Accounting: Acquisition, Depreciation, and Amortization

Asset Accounting Fundamentals

Asset Acquisition

The acquisition cost of an asset includes all expenditures necessary to prepare the asset for its intended use.

1. Acquisition Cost Calculation:

   Purchase Price + All Expenditures Needed to Prepare the Asset (e.g., repair costs, real estate fees, title fees, installation costs, transportation costs).

   Does NOT include financing charges or cash discounts.

2. Acquisition by Construction:

   Costs include three main components:

   • All materials and labor
   • Factory overhead
   • Interest on debt incurred during construction

Capitalization, Depreciation, and Amortization

Capitalization involves recording an expense as an asset to spread its cost over its useful life.

Capitalization vs. Expensing

• Capitalization (Asset Account Debit - Balance Sheet Impact):

  Reduces/defers expense, increases assets, leads to higher reported income, and potentially higher taxes. This approach is generally beneficial for financial reporting.

• Expensing (Expense Account Debit - Income Statement Impact):

  Increases current period expenses, leads to lower reported income, and potentially lower taxes. This approach is often beneficial for tax reporting.

Depreciation Calculation Methods (3 Types)

Key inputs for depreciation calculation include Acquisition Cost, Residual Value, and Total Useful Life.

1. Straight-Line Method:

   Depreciation Expense = (Cost - Residual Value) / Useful Life in Years

2. Units of Production Method:
   1. Depreciation Rate: (Cost - Residual Value) / Life in Units of Production
   2. Calculate Depreciation Expense: Depreciation Rate × Number of Units Produced for the Year
3. Accelerated Method (Double-Declining Balance):

   Depreciation Expense = Net Book Value × (2 / Useful Life in Years)

   (Net Book Value = Cost - Accumulated Depreciation)

   • Depreciation expense is limited to the asset's residual value.
   • This method is often matched with assets in their early years where depreciation expense is high, revenue is high, and repair/maintenance costs are low.

Changes in Depreciation Estimates

When estimates change, the new depreciation expense is calculated prospectively:

New Depreciation Expense = (Book Value - Residual Value) / Remaining Useful Life (All values as of the date of change)

Measuring Asset Impairment

Asset impairment occurs when there is a loss of significant utility of an asset.

• An asset is considered impaired if its Net Book Value (Cost - Accumulated Depreciation) > Estimated Future Cash Flow.
• Impairment Loss Calculation: Net Book Value - Fair Value (Market Selling Price)

Disposal of Property, Plant, and Equipment

When an asset is disposed of, the cash received is compared to its book value:

• If Cash Received > Book Value, recognize a Gain (Credit).
• If Cash Received < Book Value, recognize a Loss (Debit).

Intangible Assets: Amortization and Impairment

• Definite-Life Intangibles: These assets (e.g., patents, copyrights) are amortized over their useful lives, often using the Straight-Line Method (a cost allocation process).
• Indefinite-Life Intangibles: These assets (e.g., goodwill, trademarks with indefinite lives) are not amortized but are tested annually for impairment.
• Goodwill: Arises when one company acquires another, and the purchase price exceeds the fair market value of the net identifiable assets acquired.

Fixed Asset Turnover Rate

Formula: Net Sales / Average Net Fixed Assets

Net Sales Calculation: Sales - Sales Returns and Allowances - Sales Discounts

This ratio measures a company’s ability to generate sales given its investment in fixed assets. It indicates the sales dollars generated by each dollar of fixed assets used.