Analyzing Investing Activities. The Balance Sheet Copyright © 2010 Pearson Education, Inc....
-
Upload
tamara-mannor -
Category
Documents
-
view
216 -
download
1
Transcript of Analyzing Investing Activities. The Balance Sheet Copyright © 2010 Pearson Education, Inc....
Analyzing Investing Activities
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
The Balance Sheet
2-2
“Old accountants never die; they just lose their balance”
--Anonymous
Current (Short-term) Assets
Current (Short-term) Assets
Noncurrent (Long-term)
Assets
Noncurrent (Long-term)
Assets
Resources or claims to resources that are expected to be sold,
collected, or used within one year or
the operating cycle, whichever is longer.
Resources or claims to resources that are expected to be sold,
collected, or used within one year or
the operating cycle, whichever is longer.
Resources or claims to resources that are expected to
yield benefits that extend beyond one
year or the operating cycle,
whichever is longer.
Resources or claims to resources that are expected to
yield benefits that extend beyond one
year or the operating cycle,
whichever is longer.
ClassificationAssets
2-5
Common-Size Balance Sheet
• Expresses each item on the balance sheet as a percentage of total assets
• Reveals the composition of assets• Form of vertical ratio analysis that allows
comparison of firms• Useful for evaluating trends within a firm
and to make industry comparisons
TURKCELL $ 000 Common Size 2010 2009 2010 2009Property, plant and equipment 3,068,021 2,652,222 31.32% 28.45%Intangible assets 1,709,311 1,897,981 17.45% 20.36%GSM and other telecommunication operating licenses 955.703 1,058,098 0.01% 11.35%Computer software 547.607 595.218 0.01% 0.01%Other intangible assets 206.001 244.665 0.00% 0.00%Investments in equity accounted investees 399.622 383.49 0.00% 0.00%Other investments 33.849 34.755 0.00% 0.00%Due from Related parties 1.044 21.039 0.00% 0.00%Other non-current assets 107.277 75.12 0.00% 0.00%Trade receivables 35.024- 0.00% Deferred tax assets 2.876 2.058 0.00% 0.00%Total non-current assets 5,357,024 5,066,665 54.69% 54.36%Inventories 24.386 28.205 0.00% 0.00%Other investments 8.201 62.398 0.00% 0.00%Due from related parties 88.897 108.843 0.00% 0.00%Trade receivables And accrued income 816.151 783.752 0.01% 0.01%Other current assets 197.74 175.417 0.00% 0.00%Cash and cash equivalents 3,302,163 3,095,486 33.71% 33.21%Total current assets 4,437,538 4,254,101 45.31% 45.64%Total assets 9,794,562 9,320,766 100.00% 100.00%
ARCELIK $ 000 Common Size2010 2009 2010 2009
Donen varliklar:Nakit ve nakit benzerleri 1,317,166 904,734 17.99% 14.08%Türev finansal araçlar 1,185 4,444 0.02% 0.07%Ticari alacaklar 2,324,578 2,233,011 31.75% 34.75%Stoklar 987,526 906,786 13.49% 14.11%Diger dönen varliklar 117,984 108,980 1.61% 1.70%Toplam donen varliklar 4,748,439 4,157,955 64.85% 64.70%Duran varliklar: 0.00% 0.00%Ticari alacaklar 12,461 4,254 0.17% 0.07%Finansal yatirimlar 658,679 395,814 9.00% 6.16%Özkaynak yöntemiyle degerlenen yatirimlar 136,604 129,169 1.87% 2.01%Yatirim amaçli gayrimenkuller 5,480 6,344 0.07% 0.10%Maddi duran varliklar 1,252,245 1,244,109 17.10% 19.36%Maddi olmayan duran varliklar 461,417 439,993 6.30% 6.85%Serefiye 7,190 7,511 0.10% 0.12%Ertelenen vergi varliklar 39,244 41,509 0.54% 0.65%Toplam duran varliklar 2,573,320 2,268,703 35.15% 35.30%Toplam varliklar 7,321,759 6,426,658 100.00% 100.00%
Current Assets
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
2-8
Operating cycleTime required to purchase or manufacture
inventory, sell the product, and collect the cash
Working capitalAlso called net working capitalCurrent assets less current liabilities
Cash and Cash Equivalents Short-term, highly liquid investments that are:
Readily convertible to a known cash amount. Close to maturity date and not sensitive to interest rate
changes Companies risk a reduction in liquidity should the market
value of short-term investments decline Cash and cash equivalents are sometimes required to be
maintained as compensating balances to support existing borrowing arrangements or as collateral for indebtedness.
arcelik vestel turkcell aksa enerji logo yazilim
000%005%010%015%020%025%030%035%040%045%
Receivables Receivables are amounts due from others
that arise from the sale of goods or services, or the loaning of money
Accounts receivable refer to oral promises of indebtedness due from customers
Notes receivable refer to formal written promises of indebtedness due from others
arcelik vestel turkcell aksa enerji logo yazilim
000%
005%
010%
015%
020%
025%
030%
035%
Receivables are reported at their net realizable value — total amount of receivables less an allowance for uncollectible accounts
Management estimates the allowance for uncollectibles based on experience, customer fortunes, economy and industry expectations, and collection policies
Receivables are reported at their net realizable value — total amount of receivables less an allowance for uncollectible accounts
Management estimates the allowance for uncollectibles based on experience, customer fortunes, economy and industry expectations, and collection policies
Valuation of Receivables
TURKCELLAllowance for doubtful receivablesDuring the current year, the Group has changed its accounting estimates regarding the
determination of allowance for doubtful receivables.Formerly, the allowance for doubtful receivables was based on management’s evaluation of the
volume of the receivables outstanding, historical collection trends and general economic conditions. With the new accounting estimate, the Group maintains an allowance for doubtful receivables for estimated losses resulting from the inability of the Group’s subscribers and customers to make required payments.
The Group bases the allowance on the likelihood of recoverability of trade and other receivables based on the aging of the balances, historical collection trends and general economic conditions. The allowance is periodically reviewed.
The allowance charged to expenses is determined in respect of receivable balances, calculated as a specified percentage of the outstanding balance in each aging group, with the percentage of the allowance increasing as the aging of the receivable becomes longer.
This change is accounted as a change in accounting estimates in accordance with IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”. Based on the evaluation performed, the change in the estimates regarding the determination of allowance for doubtful receivables caused the following impact on bad debt provision expense:
Bad debt expense for the year ended 31 December 2010 Previous accounting estimate127,921Current accounting estimate 126,257Impact 1,664Due to the impracticability, the Group has not disclosed the effect of the change for the future
periods.
Arcelik
Assessment of earnings quality is often affected by an analysis of receivables and their collectibilityAnalysis must be alert to changes in the allowance—computed relative to sales, receivables, or industry and market conditions.Two special analysis questions: (1) Collection Risk
Review allowance for uncollectibles in light of industry conditionsApply special tools for analyzing collectibility:
• Determining competitors’ receivables as a percent of sales—vis-à-vis the company under analysis
• Examining customer concentration—risk increases when receivables are concentrated in one or a few customers
• Investigating the age pattern of receivables—overdue and for how long
• Determining portion of receivables that is a renewal of prior receivables
• Analyzing adequacy of allowances for discounts, returns, and other credits (2) Authenticity of Receivables Review credit policy for changes Review return policies for changes Review any contingencies on receivables
Assessment of earnings quality is often affected by an analysis of receivables and their collectibilityAnalysis must be alert to changes in the allowance—computed relative to sales, receivables, or industry and market conditions.Two special analysis questions: (1) Collection Risk
Review allowance for uncollectibles in light of industry conditionsApply special tools for analyzing collectibility:
• Determining competitors’ receivables as a percent of sales—vis-à-vis the company under analysis
• Examining customer concentration—risk increases when receivables are concentrated in one or a few customers
• Investigating the age pattern of receivables—overdue and for how long
• Determining portion of receivables that is a renewal of prior receivables
• Analyzing adequacy of allowances for discounts, returns, and other credits (2) Authenticity of Receivables Review credit policy for changes Review return policies for changes Review any contingencies on receivables
Analyzing Receivables
(C) 2007 Prentice Hall, Inc.
Receivables are Carried at Amortized Cost
2-15
When sales are made on credit, the interest imputed in the transaction is not recognized as sales revenue but as INTEREST INCOME
By using the Effective Interest Method
(C) 2007 Prentice Hall, Inc.
Illustration
2-16
%171000,50
52,000 i
)360/90/(1
The sales price of TL 52.000 was charged to customer for a sales on credit (n/90) on 1 November. If the same goods were sold at cash, the price would have been TL 50.000
The effective interest rate for the transaction is: 1/
FVi = 1
PV
Future value
PV = Present Value
n = days to maturity
i = effective interest rate
n
FV
(C) 2007 Prentice Hall, Inc. 2-17
Debit Credit
Accounts Receivable
52.000
Unearned financial income
2.000
Sales Revenue
50.000
Adjusting Entry: 31.Dec.xx (end of accounting period)
Unearned Financial Income 1.325
Interest Income 1.325
325.51)17,0(1
52.000 PV
360/30
Present Value of 52,000 at the end of the year – 30 days remain to payment day
Securitization (or factoring) is when a company sells all or a portion of its receivables to a third party
Receivables can be sold with or without recourse to a buyer (recourse refers to guarantee of collectibility)
Sale of receivables with recourse does not effectively transfer risk of ownership
Securitization (or factoring) is when a company sells all or a portion of its receivables to a third party
Receivables can be sold with or without recourse to a buyer (recourse refers to guarantee of collectibility)
Sale of receivables with recourse does not effectively transfer risk of ownership
Securitization of Receivables
•For securitizations with any type of recourse, the seller must record both an asset and a compensating liability for the amount factored•For securitizations without any recourse, the seller removes the receivables from the balance sheet
Inventories-Definitions Inventories are goods held for sale, or goods acquired
(or in process of being readied) for sale, as part of a company’s normal operations
Expensing treats inventory costs like period costs—costs are reported in the period when incurred
Capitalizing treats inventory costs like product costs—costs are capitalized as an asset and subsequently charged against future period(s) revenues benefiting
from their sale
arcelik vestel turkcell aksa enerji logo yazilim
000%
005%
010%
015%
020%
025%
030%
FIFO46%
Other4%Weighted
Average20%
LIFO30%
Use of Inventory Methods in Practice
Inventory Costing Method
Costs of Goods SoldCosts of
Goods Sold
Ending InventoryEnding
Inventory
Oldest Costs
Oldest Costs
Recent Costs
Recent Costs
First-In, First-Out (FIFO)
Cost Flow of Inventories
Costs of Goods SoldCosts of
Goods Sold
Ending InventoryEnding
Inventory
Recent Costs
Recent Costs
Oldest Costs
Oldest Costs
Last-In, First-Out (LIFO)
Cost Flow of Inventories
Average Cost
When a unit is sold, the average cost of each unit in inventory is assigned to
cost of goods sold.
When a unit is sold, the average cost of each unit in inventory is assigned to
cost of goods sold.
Cost of Goods
Available for Sale
Units available
on the date of
sale
÷
(C) 2007 Prentice Hall, Inc.
Inventory Accounting Methods
2-24
Inventory valuation may significantly affect BOTH the balance sheet and the income statement and thus the financial ratios based on these statements
Disclosure of inventory cost flow assumption found in notes
Inventory reported on balance sheet at LOWER OF COST OR MARKET (net realizable value)
Checked for impairment annually Companies may use more than one method
for inventories
Inventory on January 1, Year 2 40 @ $500$ 20,000
Inventories purchased during the year 60 @ $600
36,000Cost of Goods available for sale 100 units $
56,000
Note: 30 units are sold in Year 2 for $800 each for total Revenue of $24,000
Inventory on January 1, Year 2 40 @ $500$ 20,000
Inventories purchased during the year 60 @ $600
36,000Cost of Goods available for sale 100 units $
56,000
Note: 30 units are sold in Year 2 for $800 each for total Revenue of $24,000
Illustration of Costing Methods
Beginning Net Cost of EndingInventory + Purchases = Goods Sold +
InventoryFIFO $20,000 + $36,000 = $15,000 + $41,000LIFO $20,000 + $36,000 = $18,000 + $38,000Average $20,000 + $36,000 = $16,800 + $39,200 Assume sales of $35,000 for the period—then gross profit under each method is:
Sales – Cost of Goods Sold = Gross ProfitFIFO $24,000 -- 15,000 = $9,000 LIFO $24,000 -- 18,000 = $6,000Average $24,000 -- 16,800 = $7,200
Beginning Net Cost of EndingInventory + Purchases = Goods Sold +
InventoryFIFO $20,000 + $36,000 = $15,000 + $41,000LIFO $20,000 + $36,000 = $18,000 + $38,000Average $20,000 + $36,000 = $16,800 + $39,200 Assume sales of $35,000 for the period—then gross profit under each method is:
Sales – Cost of Goods Sold = Gross ProfitFIFO $24,000 -- 15,000 = $9,000 LIFO $24,000 -- 18,000 = $6,000Average $24,000 -- 16,800 = $7,200
Illustration of Costing Methods
Economic Profit vs. Holding Gain
In periods of rising prices, FIFO produces higher gross profits than LIFO because lower cost inventories are matched against sales revenues at current market prices. This is sometimes referred to as FIFO’s phantom profits.
The FIFO gross profit is actually a sum of two components: an economic profit and a holding gain: Economic profit = 30 units x ($800 - $600) =
$6,000 Holding gain = 30 units x ($600 - $500) =
$3,000
Prepaid expenses are advance payments for services or goods not yet received that extend beyond the current accounting period—examples are advance payments for rent, insurance, utilities, and property taxes
Prepaid expenses are advance payments for services or goods not yet received that extend beyond the current accounting period—examples are advance payments for rent, insurance, utilities, and property taxes
Prepaid Expenses
Two analysis issues:
(1) For reasons of expediency, noncurrent prepaids sometimes are included among prepaid expenses classified as current--when their magnitude is large, they warrant scrutiny
(2) Any substantial changes in prepaid expenses warrant scrutiny
Two analysis issues:
(1) For reasons of expediency, noncurrent prepaids sometimes are included among prepaid expenses classified as current--when their magnitude is large, they warrant scrutiny
(2) Any substantial changes in prepaid expenses warrant scrutiny
Analysis of Prepaids
Other current assets
Mugan-Akman 201029 Chapter 9
Accounting for Debt and Equity Investments Debt
Valuation Method
Short term
Long term(trading
securities)
Fair Value (Market Value)
Held for resale* Held to maturity
Fair market value Amortized Cost
Stocks
Valuation Method
Short term (trading
securities)
Long term
Ownership percentage
0 –20% of the investee shares*
20-50% of the
investee shares
Greater than
50% of the investee shares
Fair Value (Market Value)
Fair Value (Market Value)
Equity Method Consolidation
* usually classified as available for sale investments
Mugan-Akman 201030 Chapter 9
Investor CorporationInvestor Corporation
Minority, ActiveInvestments (typically
between 20% and50% ownership)
Minority, ActiveInvestments (typically
between 20% and50% ownership)
Majority, ActiveInvestments(greater than
50% ownership)
Majority, ActiveInvestments(greater than
50% ownership)
Minority, PassiveInvestments (less than
20% ownership)
Minority, PassiveInvestments (less than
20% ownership)
held ascurrent assets,
marketableSecurities
Trading sec
held ascurrent assets,
marketableSecurities
Trading sec
held aslong-term
Investments- Available for sale
held aslong-term
Investments- Available for sale
acquired inPurchase-
consolidation
acquired inPurchase-
consolidation
The accounting for investments depends on the purpose of the investment and the percentage of voting stock held.
Types of Investments-Stocks
Equity method of accounting
Equity method of accounting
Mugan-Akman 201031 Chapter 9
Classification of Financial Instruments
Financial assets at fair value through profit or loss: has two subcategories: Trading securities: Marketable securities – both equity and
debt securities – that are held for short-term profit purposes; and
Derivatives: financial instruments that do not have a value by themselves but derive their value from the underlying security or asset such as shares, foreign exchange, commodities etc.- except for cash flow hedges that are accounted for similar to trading securities;
Held to Maturity: Debt securities for which a firm has both the positive intent and ability to hold to maturity
Available for Sale Securities: Neither trading securities nor securities held to maturity- usually classified as long term investments.
Mugan-Akman 201032 Chapter 9
Short-Term Investments-Trading Securities
usually consist of : marketable equity securities (stocks of other companies) savings accounts (time deposits) investment funds precious metals like gold government bonds treasury bills asset securitized bonds private bonds
Characterized by frequent and active buying and selling with the object of generating profit
Typically only financial institutions hold trading securities
Since trading securities are acquired for short-term profit, unrealized gains or losses that result from adjustments to market value pass through the income statement and increase or reduce net income before there is a sale of the securities.
Mugan-Akman 201033 Chapter 9
Accounting for Marketable Equity Securities record them at the acquisition cost that
includes the price of the security plus any brokerage commissions and applicable taxes, and other costs incurred
record dividend revenue when dividends declared and later when cash is received
adjust to fair market value at the end of the accounting period-adjusting entry
Mugan-Akman 201034
Adjusting Entries-Trading Securities
Chapter 9
at the end of an accounting period, cost/carrying value of the portfolio of marketable equity securities is compared with the fair value (market value)
carrying value = fair value at the latest reporting date if the fair value of the securities is greater than the
cost -unrealized holding gain if the fair value is less than the cost - unrealized
holding loss any unrealized gains or losses on trading securities are
charged to revenues securities are reported at the fair value in the
statement of financial position
Mugan-Akman 201035 Chapter 9
Accounting for Marketable Debt Securities same as the accounting for marketable equity
securities –both are trading securities carrying value of these securities will be
compared to the market or fair value at the reporting dates
carrying value = the market value or fair value at the latest reporting date
unrealized holding gains or losses will be reflected in the income statement
Mugan-Akman 201036
Available for Sale Securities
Chapter 9
neither as trading securities or held to maturity securities held by non-financial companies usually both equity and debt securities non-derivative financial assets that are initially designated
by the management as available for sale (AFS) typically tied to a specific cash need usually classified as long-term assets measured at fair value in the statement of financial position unlike trading securities; any unrealized holding gains or
losses - shown under the owners’ equity section with the name “Unrealized Holding Gains or Losses”
realized gain or loss when these securities are sold interest or dividend revenues received from AFS securities
are reflected in the income statement
Mugan-Akman 201037
Comparison - trading and available for sale securities
Chapter 9
both are recorded at acquisition cost both are written up or down to market with adjusting entries at the
reporting date. both give rise to an unrealized holding gain or loss account upon
adjustment. unrealized holding gain or loss for trading securities is charged to revenues
–when sold, realized gain or loss is determined by taking the difference between the carrying value and proceeds from the sale
unrealized holding gain or loss for available for sale securities remains on the statement of financial position until such assets are sold-when sold, this account must then be closed and the realized gain or loss is computed by comparing the historical cost and proceeds from the sale
arcelik vestel turkcell aksa enerji logo yazilim
000%
001%
002%
003%
004%
005%
006%
007%
008%
009%
010%
Long term assets
Long-term assets—resources that are used to generate revenues (or reduce costs) in the long run
Long-term assets—resources that are used to generate revenues (or reduce costs) in the long run
Tangible fixed assets such as property, plant, and equipment
Deferred charges such as research and development (R&D) expenditures, and natural resources
Intangible assets such as patents, trademarks, copyrights, and goodwill
Financial assets such as available for sale; equity method investments
Allocation of initial costs to respective periods
Allocation—process of periodically expensing a deferred cost (asset) to one or more future expected benefit periods; determined by benefit period, salvage value, and allocation method
Terminology
• Depreciation for tangible fixed assets
• Amortization for intangible assets
• Depletion for natural resources
Allocation—process of periodically expensing a deferred cost (asset) to one or more future expected benefit periods; determined by benefit period, salvage value, and allocation method
Terminology
• Depreciation for tangible fixed assets
• Amortization for intangible assets
• Depletion for natural resources
Acquisitioncost
Acquisition cost excludes financing
charges (except in self constructed assets) and
cash discounts
All expenditures needed to prepare the asset
for its intended
use
Purchase
price
Acquisition cost of PPE
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Property, Plant, and Equipment(PP&E)
2-41
Land refers to property used in business, not investment property.
Leasehold investments are additions or improvements made to leased structures.
Construction in progress are the costs of constructing new buildings that are not yet complete.
Equipment represents the original cost of the machinery and equipment used in business operations.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Property, Plant, and Equipment (PP&E)
2-42
Proportion of fixed assets in a company’s asset structure is determined by nature of the business.
Fixed assets are most prominent at the manufacturing level.
arcelik vestel turkcell aksa enerji
logo yazilim
000%
010%
020%
030%
040%
050%
060%
operating assets
arcelik vestel turkcell aksa enerji
logo yazilim
000%
005%
010%
015%
020%
025%
030%
intangibles
Depreciation is the process of allocating the cost of a plant asset to
expense in the accounting periods benefiting from its use.
Cost
Allocation
AcquisitionCost
(Unused)
Stat of Fin Position
(Used)
Income Statement
Expense
Depreciation
Book value = original cost/revalued amount - accumulated depreciation to date – impairment losses
Factors in Computing Depreciation
The calculation of depreciation requires three
amounts for each asset: Cost.
Salvage Value.
Useful Life.
Depreciation Method
Cost - Salvage Value
Useful life in periods
DepreciationExpense per Year =
Straight-Line Method
Depreciation Rate = 1/ useful life in periods
If useful life is 5 years, straight line rate is = 1/5 = 20%
Straight-Line Method gives the same amount of depreciation
expense every year
Step 1:
Step 2:
Double-declining-balance rate = 2 ×
Straight-linedepreciation rate
Step 3:
Depreciationexpense =
Double-declining-balance rate ×
Beginning periodbook value
Ignores salvage value
Straight-linedepreciation rate =
100 % Useful life
Double-Declining-Balance Method
DepreciationPer Unit
= Cost - Salvage Value Total Units of Production
Step 1:
Step 2:
Depreciation Expense =
DepreciationPer Unit ×
Units Producedin Period
Activity (Units-of-Production) Method
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Depreciation Methods-comparison
2-48
Straight-line method allocates an equal amount of expense to each year of the depreciation period.
Accelerated method apportions larger amounts of expense to earlier years of the asset’s depreciable life – in Turkey most common one is double declining.
Units-of-production method bases depreciation expense on actual use.
Companies can use different methods for different asset classes.
number of companies
% SL % ACC
1998-2006 48591 79,53 20,47
Economic consequences of firms’ depreciation method choice: Evidence from capital investments ☆Scott B. Jacksona,
Xiaotao (Kelvin) Liub,
Mark Cecchinia
SIC code description % SL % ACC
SIC code description % SL % ACC
Metal mining 10.89 89.11 Transportation equipment 74.75 25.25
Oil and gas extraction 17.39 82.61 Measuring, analyzing, and controlling instruments
82.07 17.93
Building construction general contractors 79.37 20.63 Miscellaneous manufacturing industries 76.03 23.97
Food and kindred products 86.05 13.95 Wholesale trade durable goods 75.96 24.04
Textile mill products 84.75 15.25 Wholesale trade non-durable goods 78.47 21.53
Apparel and other finished products made from fabrics
77.88 22.12 General merchandise stores 95.08 4.92
Furniture and fixtures 80.60 19.40 Food stores 92.73 7.27
Paper and allied products 63.25 36.75 Apparel and accessory stores 93.33 6.67
Printing, publishing, and allied industries 81.75 18.25 Home furniture, furnishings, and equipment stores
93.22 6.78
Chemicals and allied products 84.78 15.22 Eating and drinking places 93.71 6.29
Petroleum refining and related industries 38.89 61.11 Miscellaneous retail 87.24 12.76
Rubber and miscellaneous plastics products 79.83 20.17 Business services 86.86 13.14
Stone, clay, glass, and concrete products 66.22 33.78 Motion pictures 51.55 48.45
Primary metal industries 76.19 23.81 Amusement and recreation services 83.93 16.07
Fabricated metal products 81.58 18.42 Health services 91.55 8.45
Industrial and commercial machinery and equipment81.75 18.25 Engineering, accounting, management, and related services
81.98 18.02
Electronic and other electrical equipment and components
83.67 16.33 Other SIC codes 73.91 26.09
Economic consequences of firms’ depreciation method choice: Evidence from capital investments ☆Scott B. Jacksona, Xiaotao (Kelvin) Liub, Mark Cecchinia
Capitalization
Capitalization—process of deferring a cost that is incurred in the current period and whose benefits are expected to extend to one or more future periods For a cost to be capitalized, it must meet each of the following criteria:
• It must arise from a past transaction or event
• It must yield identifiable and reasonably probable future benefits
• It must allow owner (restrictive) control over future benefits
Capitalization—process of deferring a cost that is incurred in the current period and whose benefits are expected to extend to one or more future periods For a cost to be capitalized, it must meet each of the following criteria:
• It must arise from a past transaction or event
• It must yield identifiable and reasonably probable future benefits
• It must allow owner (restrictive) control over future benefits
(C) 2007 Prentice Hall, Inc.
Valuation of PPE
2-51
1. Option: Property, plant & equipment are valued at cost less accumulated depreciation and allowance for impairment
2. Option: Property, plant & equipment are valued at revalued amount less accumulated depreciation and allowance for impairment
Impairment—process of writing down asset value when its expected (undiscounted) cash flows are less than its carrying (book) value
Two distortions arise from impairment: Conservative biases distort long-lived asset
valuation because assets are written down but not written up
Large transitory effects from recognizing asset impairments distort net income.
Valuation Analysis Valuation emphasizes objectivity of historical cost, the conservatism principle, and accounting for the money invested
Limitations of historical costs: Balance sheets may not reflect market values after
initial acquisition Not especially relevant in assessing replacement
values- either entry or exit values Not comparable across companies—even if two land
pieces side by side– may be purchased at different times
Not particularly useful in measuring opportunity costs Collection of expenditures reflecting different
purchasing power
Total cost,including
exploration anddevelopment,is charged to
depletion expenseover periodsbenefited.
Extracted fromthe natural
environmentand reportedat cost less
accumulateddepletion.
Examples: oil, coal, gold
Natural resources (wasting assets)—rights to extract or consume natural resources
Natural Resources
Depletion is calculated using theunits-of-production method.
Unit depletion rate is calculated as follows:
Total Units of Capacity
Cost – Salvage Value
Depletion of Natural Resources
Depletion of Natural Resources
Total depletion cost for a period is:
Unit Depletion
Rate
Number of Units
Extracted in Period×
Totaldepletion
costIf not
Inventory
If sold Cost of goods sold
• Assess reasonableness of depreciable base, useful life, and allocation method• Review any revisions of useful lives• Evaluate adequacy of depreciation—ratio of depreciation to total assets or to other size-related factors• Analyze plant asset age—measures include
Average total life span = Gross plant and equipment assets / Current year depreciation expense. Average age = Accumulated depreciation / Current year depreciation expense. Average remaining life = Net plant and equipment assets / Current year depreciation expense.
Average total life span = Average age + Average remaining life
(these measures also reflect on profit margins and financing requirements)
Analyzing Depreciation and Depletion
Noncurrent assetswithout physical
substance.
Noncurrent assetswithout physical
substance.
Useful life isoften difficultto determine.
Useful life isoften difficultto determine.
Usually acquired for operational
use.
Usually acquired for operational
use.
IntangibleAssets
Often provideexclusive rights
or privileges.
Often provideexclusive rights
or privileges.
Intangible Assets
Accounting for Intangible Assets
Patents Copyrights Leaseholds Leasehold
Improvements Goodwill- only
recognized in company acquisitions – not amortized
Trademarks and Trade Names
Record at cost, including
purchase price, legal
fees, and filing fees.
Analyzing Intangibles and Goodwill Search for unrecorded intangibles and
goodwill—often misvalued and most likely exist off-balance-sheet
Examine for unusually good earnings as evidence of goodwill Review amortization periods—any likely bias is in the direction of less amortization and can call for adjustments Recognize goodwill has a limited useful life--
whatever the advantages of location, market dominance, competitive stance, sales skill, or product acceptance, they are affected by changes in business
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Other Assets
2-60
Can include many other noncurrent items:• Property held for sale• Start-up costs in connection with a new
business• Cash surrender value of life insurance
policies• Long-term advance payments• Long-term investments