Reaction Paper on Accounting
Buildings, machinery, equipment, furniture, fixtures, computers, cars and trucks are examples of assets that will last for more than one year, but will not last indefinitely. These are some examples of long-lived non-monetary assets. When these assets were acquired, the company has made an expenditure. If the company will benefit in the curret period, the cost of the goods are expenses. If the benefits are expected in future periods, the costs are assets during the current period and the expenditures are capitalized.
The cost of these non-monetary assets should be matched with the revenues that are obtained from its use in the future periods. In general there are two types of long-lived assets: the tangible assets and the intangible assets. A tangible asset is an asset that has physical substance. Examples are land, plant and equipment and natural resources. An intangible asset has no physical substance. These will include good will, patent rights and copyrights. Land is not normally amortized because its useful life is assumed to be indefinitely long.
Reaction Paper on Accounting Essay Example
Depreciation is process of converting the original cost of plant and equipment assets to expense. Depletion on the other hand is the process of converting the cost of the natural resource assets to expense. If the intangible assets are converted to expense, it is called amortization. With plant and equipment, betterments or repairs and maintenance can be done. To differentiate, maintenance will keep the asset in good condition but not in a better condition than when it was purchased. On the other hand, betterment makes the asset better or extends its useful life beyond the original estimate of useful life.
Thus, betterment is added to the cost of the asset while repair and maintenance costs are considered period costs. What are the items to be included in the cost of an asset? The cost of a property, plant or equipment includes all expenditures that are necessary to make the asset ready for its intended use. In general, non-monetary assets are recorded at cost. However there are certain exceptions to this. If the entity receives an asset by donation or pays less than the market value of the asset, the asset is recorded at its fair value.
Plant and equipment undergo depreciation compared to land that does not have a limited useful life. Therefore, a portion of the cost of the asset is charged as an expense in each of the accounting periods in which the asset provides benefits to the entity. Depreciation is considered to be an expense since costs of goods and services consumed by an entity are expenses. Generally, long-lived tangible assets’ useful life is limited by either deterioration or obsolescence. Deterioration is the physical wearing out of an asset. Physical life is the time until an asset wears out.
Obsolescence is the loss of usefulness of an asset not related to its physical condition. Service life is the time until the asset becomes obsolete. To make an estimate of the depreciation expense, we need to estimate the service life of the asset, the residual value at the end of its service life and the method of depreciation to be used. The service life is the estimate of how long the asset will be used. The residual value is the estimated amount that a company will receive when it disposes of an asset at the end of the asset’s service life. This value is often estimated to be zero.
There are three conceptual methods of depreciation to be used. The straight line method views a fixed assets as providing its services in a level stream and charges as an expense an equal fraction of the net cost of the asset each year. The most common method of depreciating assets for financial statement purposes is the straight-line method. Accelerated depreciation is an alternative to the straight-line method. Compared to the straight-line method, accelerated depreciation methods provide for more depreciation in the early years of an asset’s life but then less depreciation in the later years.
This can be done using the double-declining-balance method and sum-of-the-years’-digits method. Under any depreciation method, the maximum depreciation during the life of an asset is limited to the cost of the asset. The difference in depreciation methods involves when you will report the depreciation. It’s a matter of timing. When property, plant, and equipment are disposed of, their dollar amounts must be removed from the accounts and any other assets received must be recorded.
One reason knowledge of the effects of disposals of property, plant, and equipment are important to managers is that such disposals can result in useful resources. Another reason is that such disposals can affect the company’s net income. When considering disposing of property, plant, and equipment, managers must consider whether the advantages of obtaining usable resources are enough to offset the possible negative income effects. It is also possible to increase resources through the disposal of property, plant, and equipment. In such cases, resources and sources of resources increase.
The increases in sources of resources are called gains and appear on the income statement as part of other revenues and expenses. Some properties and equipments are disposed by trading them in or exchanging them for new assets. If the trade in is similar, its value is assumed to be the net book value. If the asset traded is dissimilar, its value is its estimated fair value. Wasting assets refer to natural resources such as coal, oil or gas. Companies usually acquired these assets as a result of exploring for them. These exploration costs are accounted for in two ways.
When all explorations costs of a year are capitalized as the asset value of the reserves discovered during that year, we are using the full cost method. When only the costs incurred at locations in which the reserves are discovered are capitalized, we are using the successful efforts method. Depletion is the process of amortizing the cost of natural resources. It has the same principle as that of depreciation. If we will look at intangible assets, there are generally three categories: intangible assets with limited useful lives, intangible assets with indefinite useful lives and goodwill.
Those with limited useful lives such as patents are converted to expenses over a number of accounting periods in a process called amortization. Those with indefinite useful lives are not amortized. To be considered as having indefinite life, there should be no legal, regulatory, or contractual factors that limit its useful life. Goodwill arises when a company acquires another entire business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase.
Goodwill cannot be amortized. ntangible assets include copyrights, patents, goodwill, trade names, trademarks will be reported at cost (or lower) on the balance sheet after property, plant and equipment. Why do we need to take into account depreciation? Depreciation plays an important role in financial accounting. This helps managers monitor their fixed assets over a period of time. Fixed assets are valuable to a business because these are the types of assets which an organization will likely own for a period of years. These assets, are the ones that are significant investments and are used to serve or produce the items which keep the business selling.
Depreciation is an important decision making tool when it comes to long-term assets. Managers can use these figures to help them make decisions for upgrades, replacements or repairs. There are two main benefits of depreciating assets. First, an accurate appraisal allows the asset to be recorded in the company’s financial statements at the value that it would command in the market if it were to be sold. This way, should an actual sale take place, the company does not incur a loss. Secondly, the company does not have to pay taxes on provisions for depreciation.
The money saved can be either invested back in the company for expansion purposes or distributed to equity holders as dividends. I am currently associated with a service company. A service company uses its employees to provide a service for the customer. Some service companies purchase expensive equipment to provide the service, such as a vehicle. Other service companies rely on human labor more than equipment and only purchase a minimal amount of assets. In my case, since our company conducts review classes for nursing students who will be taking the Nurse Licensure exam we rely more on human labor than on equipments.
We also conduct seminars and trainings for registered nurses. Being primarily a service provider company, our long-lived non-monetary assets are very limited. In fact, one could primarily say that the most important asset of our company is the pool of lecturers. These lecturers are basically the ones that provide service that generate revenue for the company. Our non-monetary assets are the service vehicles needed to transport the materials to be used in the different branches of the review center.
The company also has several computers, laptops and LCD projectors to be used for the review classes. Recently, the company has acquired medical equipments and dummies for the trainings for life support. For these assets, the company is using the straight-line method for calculating and estimating the depreciation. The method is designed to reflect the consumption pattern of the underlying asset, and is used when there is no particular pattern to the manner in which the asset is to be used over time which we can say is true for our non-monetary assets.
Considered to be the simplest and most commonly used depreciation method, the residual value is subtracted from the purchase or acquisition price of the assets and divided by the total productive years the asset can reasonably be expected to benefit the company. We don’t use the accelerated depreciation method since one of the reasons for using it is to reduce the reported amount of taxable income over the first few years of an asset’s life, so that the company pays a smaller amount of taxes during those early years.
In our company’s case, the computers and laptops usually have the shortest service life compared to the other long-lived assets we have due to the periodic updates and improvements in technology. These assets have longer physical life compared to their service life. At this point, when technology is fast-paced, it is quite difficult to predict the actual service life of the laptops and computres. As for the building where the offices and classes are conducted, these are actually leased properties only. Thus any improvements made to the buildings and classrooms, technically belongs to the owner of the building.
Leasehold improvements are items that are permanently attached to property. The leasehold improvements will go to the lessor at the end of the lease contract. Based on our book leasehold improvements should be depreciated or amortized according to the lessee’s normal depreciation policy except that the time period shall be the shorter of the useful life of the leasehold improvements, or the remaining years of the lease. The remaining years of the lease include the years in the lease renewals that are reasonably assured.