Definitions 

Long-lived assets—resources that are used to generate revenues (or reduce costs) in the long run
Tangible fixed assets such as property, plant, and equipment
Intangible assets such as patents, trademarks, copyrights, and goodwill
Deferred charges such as research and development (R&D) expenditures, and natural resources

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 

Allocation   

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

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.

Plant Assets & Natural Resources  

Plant Assets & Natural Resources 
Plant Assets Costing Rule 

Valuation Analysis         

Valuation emphasizes objectivity of historical cost, the conservatism principle, and accounting for the money invested
 
 Limitations of historical costs:
 • Balance sheets do not purport to reflect market values
 • Not especially relevant in assessing replacement values
 • Not comparable across companies
 • Not particularly useful in measuring opportunity costs
 • Collection of expenditures reflecting different purchasing power  

Depreciation

Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use.
Depreciation

Factors in Computing Depreciation

The calculation of depreciation requires three amounts for each asset: Cost.
  1.  Salvage Value.
  2.  Useful Life.
  3.  Depreciation Method

Comparing Depreciation Methods

Comparing Depreciation Methods

Natural Resources        

natural resource

Analyzing Depreciation and Depletion

•   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)
Intangible Assets 
Accounting for Intangible Assets
  1.  Patents
  2.  Copyrights
  3.  Leaseholds
  4.  Leasehold  Improvements
  5.  Goodwill
  6.  Trademarks and  Trade Names 

Analyzing Intangibles and Goodwill

  • Search for unrecorded intangibles and goodwill—often misvalued and most likely exist off-balance-sheet
  • Examine for superearnings 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

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