Chap8Long-livedAssets(财务报表分析,加州大学MBA).ppt

Short-lived and Long-lived Assets Short-lived assets a) On Jan. 1, buy insurance coverage for the year, and use it up by Dec. 31. In this case, the asset only lives within a year and the expenditure on the insurance coverage becomes expense right away. b) Inventory lives between the day of purchase and the day of being sold. The expenditure on inventory becomes expense when inventory is sold. Short-lived and Long-lived Assets Long-lived assets Production equipments are used for many years, they long live. The expenditure on equipments becomes expenses gradually（缓慢地）year after year. If the expenditure becomes expenses over many years, a challenging question is that how we allocate the total expenditure into expenses among these years. And how we allocate affects net income and total assets of these years. Long-lived Assets Income Statement Revenues COGS Depreciation expenses （折旧费用） Net Income Balance Sheet Assets Cash A/R Inventory Property, plants and equipments Long-lived Assets- some terminologies Acquisition value of asset （获取价值）: all expenditures occurred to put the asset ready for use. For an equipment, it includes: price paid to manufacture, transportation fees, fees paid to technicians to adjust the equipment, expenditures to build a concrete base for the equipment, Salvage value (residual value)（残留价值）: When the company no longer needs the equipment, the money it gets for disposing the equipment. If it sells the equipment, the money it receives from buyer net of any selling cost is salvage value; if it destroys the equipment, salvage value is ? Long-lived Assets- some terminologies 3. Assets useful life: number of years that the asset is used in production. An machine may have useful life of 5 years, while an intangible asset (e.g., patent) may have useful life of 40 years. 4.Depreciation: the process of allocating the depreciation base over the years of the assets useful life. Long-lived Assets- some terminologies 5. Depreciation base: Acquisition value minus salvage value. This amount will be allocated over the years of the assets useful life. 6. Depreciation expense: the amount of deprecation base that is allocated into a particular year. 7. Amortization expense: deprecation expense for intangible assets 8. Depletion expense: depreciation expense for natural resource assets, such as gold mine. Depreciation method Markam Corp acquires a new machine costing $20,000. The firm expects to use the machine for 5 years and that the salvage value will be $2,000. Depreciation base = $20,000 - $2,000 = $18,000 Depreciation method for financial reporting purpose Straight-line method Accelerated method 2.1 Sum-of-the-years-digits method 2.2 Double-declining method (DDB) Straight Line Depreciation Allocate the depreciation base equally among the years of useful life, in this case, it is five years. The straight line rate would be 1/( 5 years) or 20% per year Accelerated depreciation: Sum of Years Digits Method Depreciation charge is calculated as a variable rate times depreciation base. The variable rate is equal to the number of years remaining (including the current year) divided by the sum of the years digits The sum of the years digits is the sum of the numbers 1, 2, 3, , up to and including the last year of useful life For a 5 year useful life, the sum is 1+2+3+4+5 = 15 Accelerated depreciation: Sum of Years Digits Method 1. Depreciation base: $20,000 - $2,000 = $18,000 2. The sum of the years digits is 1+2+3+4+5 = 15. 3. The depreciation rate is the remaining years / the sum of the years digits Depreciation Charge (rate*basis) Accelerated depreciation-double declining balance method Depreciation charge is calculated as a fixed rate times the net book value of the asset Net book value is acquisition value reduced by accumulated depreciation but NOT reduced by salvage value This is one of the very rare methods that does not subtract salvage value The reason is that the method produces declining depreciation charges and when the net book value is equal to salvage, no further depreciation is taken. So this method does reduce the net book value to salvage The fixed rate must be greater than the straight line rate for the depreciation to be accelerated Accelerated depreciation-double declining balance method The straight line rate would be 1/( 5 years) or 20% Double declining balance uses a fixed rate of twice the straight line rate, or 40% $2,320 Impact of different methods on I/S and B/S YearDep. Exp.- SL Dep. Exp.- Sum-of- digits Ending net asset book value - SL Ending net asset book value sum- of-digits 1$3,600 $6,000 $16,400 $14,000 23,6004,80012,8009,200 33,6003,6009,2005,600 43,6002,4005,6003,200 53,6001,2002,0002,000 Totals$18,000$18,000 Time S D A E Acquisition cost - salvage N Dep. expense N-no depreciation; A-accelerated depreciation; S-straight line Depreciation; D-decelerated depreciation; E-immediate expensing Take-away Different depreciation methods end up with different depreciation expenses. But over the entire useful life of the asset, combined depreciation expenses are the same (equal to depreciation base) regardless of the method. The depreciation process is a process of cost allocation, not a decline in the value of the asset. The (market) value of the asset may increase or decrease during the useful life of the asset, but depreciation process will go on as if no change has occurred. Depreciation-the accounting process using SL When purchase the machine, Dr. Machine 20,000 Cr. Cash 20,000 2. Dec. 31 of year 1 Dr. Depreciation expense 3,600 Cr. Accumulated depreciation 3,600 3. Dec. 31 of year 2 Dr. Depreciation expense 3,600 Cr. Accumulated depreciation 3,600 Depreciation-the accounting process using SL Machine 20,000 Accumulated Depreciation 3,600 3,600 Year 1 B/S Machine 20,000 Less Acc. Dep. 3,600 Net machine: 16,400 Year 2 B/S Machine 20,000 Less Acc. Dep. 7,200 Net machine: 12,800 Earnings management through long- lived assets Through Choosing depreciation method Through estimating useful life and salvage value Through changing useful life and/or salvage value estimates in the middle of use Through taking impairment charges Through Choosing depreciation method EM through switching between depreciation methods is difficult. 1) If a firm is using accelerated depreciation method, and want to switch to straight-line method to boost earnings, then the firm must have assets in the early stage of their life. 2) Auditors wont allow firms to switch often. Through estimating and changing useful life and salvage value An easier way to do EM through long-lived assets is to make estimates before the asset is put to use, or change estimates of useful life and salvage value while the asset is in use. After all, who is in the best position to make these estimates? The company management! Similar to the example of estimating bad-debt expense, a small change in these estimates could result in a large change in net income. S. Basu 1997, J. of Accounting And Economics The bad news, when useful life Is shortened by 3 years, Are recognized in the 4th year all at once Following conservative principle Through taking impairment charges Up to now, we have assumed that the real value of the assets does not change during the life of the assets. So judgment is exercised on estimating useful life and salvage value. But the real value of the long-lived assets does change over time. Value change of long-lived assets The value of long-lived assets may increase: 1) Near a piece of land, an inter-state high way is built; 2) The market condition changes, and the products produced by a type of machine sell again, although the machine has been fully depreciated. Value change of long-lived assets The value of long-lived assets may decrease: 1) The highway on precious slide is not built; 2) Obsolescence: 2.1) A new invention leads to a new machine that is better than the old one both technologically and economically; 2.2) New generation of computers come out to replace old generation of computers; 2.3) A new product substitutes the product manufactured by a type of machine. How to recognize value-changes of long- lived assets? GAAP does not allow firms to recognize increases in the value of long-lived assets GAAP allows firms to recognize decreases in the value of long-lived assets, and following conservative principle, the firms have to recognize the decreases all at once. The decrease recognized is called impairment loss. EM through taking impairment loss It is appropriate to take impairment loss if the asset is indeed impaired; however, many companies use this opportunity to manage earnings. The idea is that taking impairment loss in a year results in very low earnings; but future earnings will become better because no or less depreciation expenses need to be taken. (remember the Sears story with excessive bad-debt expense?) Time Net income Not taking Impairment loss Taking impairment loss Assuming there is no Real impairment EM through taking impairment loss Furthermore, companies tend to emphasize to investors earnings from continuing operations, which do not include the impairment loss (decrease in earnings) in the impairment year, but do include the benefits (increase in earnings) in future years. Management achieves a win-win scenario. Taking an impairment for EM purpose sometimes are referred to as a “big bath”, a “write-off”; a “write-down”, “clearing the deck”. Variations of Impairment Charges Assets write-down on tangible assets such as buildings, machines, equipments, etc. Acquired R but if AOL does not capitalize the subscriber-acquisition expenditures, earnings would be a loss of 90 cents. Look who is practicing it: the one the only AOL! But in fiscal first quarter of 1997, AOL reverses its policy on subscription expenditures. It takes a $385 millions (impairment) charges to write-off subscriber-acquisition costs; and start to expense these expenditures from 1997. The effect, 1997 earnings will be very low, but in future years, AOL does not take depreciation expenses to subscriber-acquisition costs, which results in higher future earnings. Retirement of Assets When the asset is removed from service, either sold or disposed, the accounts need to reflect this change. There are three adjustments: The asset account must be closed (removed) The accumulated depreciation account for that asset must also be closed (removed) And any gain or loss on retirement needs to be recognized. If the depreciation schedule was perfect, the asset value less the accumulated depreciation would equal exactly the salvage value. Differences give rise to a gain (if a credit) or a loss (if a debit). Retirement of Assets Dr. cash (received or asset) $1,500 Dr. accum.depr (to remove the account)18,000 Dr. loss on retirement (plug) 500 Cr. equipment (to remove the asset) 20,000 Earnings management through asset sales (recall the inventory write-down EM tricks？) Similarly, if the company has a bad operating earnings year, it may sell some non-essential assets to realize large amount of gains to boost net income. Of course, the current market price of the assets must be greater than their book values to realize gains from sales. Intangible Assets and Amortization Assets may provide future benefits without having physical form; for example, a patent or copyright. Such assets are called intangible assets. Intangible assets may have a limited life. Patents expire after 20 years in the U.S. Intangible assets are reduced in value in recognition of this limited life. The revaluation is similar to depreciation but is called amortization. Specific examples of intangibles are a. Research and development b. Patents c. Advertising d. Goodwill Intangible Assets and Amortization Accountants face two key issues with regards to intangible assets: Have the expenditures made to acquire or develop the intangible asset generated sufficient future benefits that the expenditures should be capitalized? Have the expenditures produced no future benefit for the firm or benefits so hard to quantify or measure that the the expenditures shou