Accounting Ch. 9, 10, 11

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bad debts

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uncollectible accounts

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expense recognition (matching) principle

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violated by Direct Write-Off Method

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Materiality Constraint

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states that an amount can be ignored if its effect on financial statements is unimportant to users' business decisions, does permit the use of the direct write-off method if bad debts expense is not material.

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Two methods for uncollectible accounts

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1. Direct write-off method

2. allowance method

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Banker's rule

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to simplify computations, bankers used a 360-day year

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land improvements

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(such as parking lot surfaces, driveways, fences, shrubs, and lighting systems) have limited useful lives and are used up. Although the costs of these improvements increase the usefulness of the land, they are charged to a separate Land Improvement account so that their costs can be allocated to the periods they benefit.

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The three factors that determine depreciation are

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(1) cost, (2) salvage value, and (3) useful life.

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Modified Accelerated Cost Recovery System (MACRS)

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The U.S. federal income tax law has rules for depreciating assets. These rules include the Modified Accelerated Cost Recovery System (MACRS), which enables straight-line depreciation for some assets but requires accelerated depreciation for most kinds of assets. MACRS is not acceptable for financial reporting because it often allocates costs over an arbitrary period that is less than the asset's useful life and it fails to estimate salvage value.

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Revenue expenditures

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additional costs of plant assets that do not materially increase the asset's life or productive capabilities. They are recorded as expenses and deducted from revenues in the current period's income statement. Examples of revenue expenditures are cleaning, repainting, adjustments, and lubricants.

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Capital expenditures

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additional costs of plant assets that provide benefits extending beyond the current period. They are debited to asset accounts and reported on the balance sheet and will be expensed in the future. Capital expenditures increase or improve the type or amount of service an asset provides. Examples are roofing replacement, plant expansion, and major overhauls of machinery and equipment.

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Ordinary repairs

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are expenditures to keep an asset in normal, good operating condition. Ordinary repairs do not extend an asset's useful life beyond its original estimate or increase its productivity beyond original expectations. Examples are normal costs of cleaning, lubricating, adjusting, and replacing small parts of a machine. Ordinary repairs are treated as revenue expenditures.

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Betterments/extraordinary repairs

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Accounting for betterments and extraordinary repairs is similar—both are treated as capital expenditures. Betterments are expenditures that make a plant asset more efficient or productive. A betterment often involves adding a component to an asset or replacing one of its old components with a better one; it might or might not increase the asset's useful life. Extraordinary repairs are expenditures extending the asset's useful life beyond its original estimate. Because betterments and extraordinary repairs benefit future periods, these costs are debited to the related plant asset account.

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Natural resources

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Natural resources are assets that are physically consumed when used. Examples include standing timber, mineral deposits, and oil and gas fields. These assets represent soon-to-be inventories of raw materials that will be converted into one or more products by cutting, mining, or pumping. Until that conversion takes place, the natural resources are reported on the balance sheet under either plant assets or their own separate category.

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Depletion

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Depletion is the process of allocating the cost of a natural resource to the period when it is consumed. The depletion expense per period is usually based on units extracted from cutting, mining, or pumping.

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Intangible assets

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nonphysical assets used in operations that confer on their owners' long-term rights, privileges, or competitive advantages. An intangible asset is recorded at cost when purchased.

Intangibles must be separated into those with limited lives and those with indefinite lives. If an intangible has a limited life, its cost is systematically allocated to expense over its estimated useful life through the process of amortization. The straight-line method (similar to that used for depreciation) is ordinarily used for amortizing intangibles. On the other hand, if an intangible asset has an indefinite life, it is not amortized.

Examples of intangible assets include patents, copyrights, franchises, licenses, trademarks, goodwill, and leaseholds.

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Patent

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an exclusive right granted to its owner to manufacture and sell a patented item or to use a process for up to 20 years. When a patent is purchased, its cost is debited to the Patents account. (The costs of research and development leading to a patent are expensed when incurred because the future benefit is not assured when the R&D is performed.) If the owner is forced to defend a patent and the patent is successfully defended, the legal costs are added to the Patents account. A patent's cost is amortized over its estimated useful life (not to exceed 20 years).

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Copyrights

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gives its owner the exclusive right to publish and sell a musical, literary, or artistic work during the life of the creator plus 70 years. Unless it is purchased, the only identifiable cost of a copyright is the fee paid to register it. If this fee is immaterial, it is simply expensed. If material, the fee is added to the Copyrights account. The costs of a copyright are amortized over its useful life (not to exceed 70 years).

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Franchise and licenses

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rights that a company or government grants an entity to deliver a product or service under specified conditions. Many organizations grant franchise and license rights. The costs of franchises and licenses are debited to the Franchises and Licenses account and amortized over the lives of the agreements. If an agreement is for an indefinite or perpetual period, those costs are not amortized.

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trademark

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symbol, name, phrase, or jingle identified with a company, product, or service. Ownership is best established by registering a trademark or trade name with the government's Patent Office. If a trademark or trade name is purchased, its cost is debited to an asset account. (The cost of developing, maintaining, or enhancing the value of a trademark or trade name is expensed when incurred.) A trademark or trade name is amortized over its expected life. If the company plans to renew its rights indefinitely, the cost is not amortized.

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Goodwill

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the amount by which a company's value exceeds the value of its individual assets and liabilities. It results from superior management, a skilled workforce, good supplier or customer relations, quality products or services, good location, or other competitive advantages. Goodwill is not recorded unless an entire company or business segment is purchased. Goodwill is measured as the excess of the cost of an acquired entity over the value of the acquired net assets. Goodwill is recorded as an asset and it is not amortized.

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leasehold

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A leasehold refers to the rights the lessor grants to the lessee under the terms of the lease. A leasehold is an intangible asset for the lessee that is amortized over the remaining life of the lease.

A lessee sometimes pays for alterations or improvements to the leased property such as partitions, painting, and storefronts. These alternations and improvements become part of the property and revert to the lessor at the end of the lease. The lessee debits these alterations and improvements to a Leasehold Improvements account. Leasehold improvements are amortized over the useful life of the improvements or the life of the lease, whichever is shorter.

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guarantor

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a guarantor of a debt will take the responsibility to pay for someone's debt if the loan is defaulted.

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inadequacy

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Insufficient capacity of a company's plant assets to meet its growing productive demands

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Obsolescence

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the condition of a plant asset that is no longer useful in producing goods or services with a competitive advantage because of new inventions and improvements

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impairment

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When there is a permanent decline in the fair value of an asset relative to its book value