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Chapter 9: Problem 11

Identify two types of capital expenditures. What is the proper accounting for capital expenditures?

Short Answer

Expert verified
The two types are acquisition of new assets and improvement of existing assets. Capital expenditures are capitalized and depreciated or amortized over time.

Step by step solution

01

Identify Types of Capital Expenditures

Capital expenditures (CapEx) are significant investments in long-term assets. The two main types of capital expenditures are: 1. **Acquisition of New Assets**: This includes buying new machinery, buildings, or equipment. These are expenditures made to acquire assets that will benefit the business for multiple years. 2. **Improvement of Existing Assets**: This includes expenditures that enhance the capacity or extend the useful life of existing assets, like upgrading machinery or renovating a building.
02

Understand Capital Expenditure Characteristics

Capital expenditures have key characteristics: they involve a substantial investment, provide future economic benefits, and have a long-term impact on the company's financial position. These expenditures are not charged to expense in the period incurred but are capitalized on the balance sheet.
03

Accounting for Capital Expenditures

Proper accounting for capital expenditures involves capitalizing the expenditure by recording it as an asset on the balance sheet, rather than expensing it immediately. The cost is then allocated over the asset's useful life through a process called depreciation (for tangible assets) or amortization (for intangible assets). This allocation reflects the asset's consumption of economic benefits over time.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Financial Position
The financial position of a company refers to its overall economic health and stability at a specific point in time. It provides a snapshot of everything a business owns and owes, as well as the value left for shareholders if the company were to liquidate its assets.
Understanding the financial position is critical for assessing a company鈥檚 ability to generate future cash flows and handling unexpected liabilities.
  • The **importance of financial position** lies in its ability to influence investor decision-making, as a strong financial position suggests potential growth and profitability.
  • A company鈥檚 **financial position** is often evaluated through various financial statements, including the balance sheet and income statement.
This overview helps stakeholders make informed choices about investing money, extending credit, or negotiating contracts with the company.
Depreciation
Depreciation is a key accounting concept that involves distributing the cost of a tangible asset over its useful life.
This process ensures that the expense is matched with the revenue generated by the asset, providing a more accurate representation of a business's profitability over time.
  • Unlike expenses that are recorded immediately, depreciation spreads the cost over several periods.
  • For example, if a business purchases machinery, the depreciation expense reflects how much of the machinery鈥檚 value is used each financial year.
Depreciation is calculated using various methods, such as straight-line or declining balance. Each method has its way of reducing asset value annually, affecting both net income and tax obligations.
Helps businesses preserve cash flow by not expensing large investments all at once, allowing for more strategic financial planning.
Balance Sheet
A balance sheet is a financial document that provides a summary of what a company owns and owes at a particular timing point.
It is structured into three main sections: assets, liabilities, and shareholders鈥� equity. This allows anyone viewing it to understand the company's financial position.
  • **Assets** are divided into current assets, such as cash and inventory, and non-current assets, like machinery and buildings.
  • **Liabilities** include short-term obligations, like accounts payable, and long-term debts, such as bonds payable.
  • **Shareholders鈥� equity** represents the owner's claim after all liabilities have been settled.
Balance sheets are essential for assessing the liquidity, solvency, and capital structure of a company.
They play a vital role in guiding investment and credit decisions by illustrating how effectively a company utilizes its resources and manages its debts.

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Most popular questions from this chapter

Davidson Company sold one of its worn-out delivery trucks on December 31,2019 . The truck was purchased on January 1, 2016, for \(\$ 50,000\) and was depreciated on a straight-line basis over a fiveyear life. There was no salvage value associated with the truck. If the truck was sold for \(\$ 14,000\), what was the amount of gain or loss recorded at the time of the sale? a. \(\$ 4,000\) loss c. \(\$ 4,000\) gain b. \(\$ 14,000\) gain d. \(\$ 6,000\) loss

Disposal of Plant Asset Crystal Company has a used delivery truck that originally cost \(\$ 24,200\). Straight-line depreciation on the truck has been recorded for three years, with a \(\$ 3,500\) expected salvage value at the end of its estimated six-year useful life. The last depreciation entry was made at the end of the third year. Four months into the fourth year, Crystal disposes of the truck. Required Prepare journal entries to record: a. Depreciation expense to the date of disposal. b. Sale of the truck for cash at its book value. c. Sale of the truck for \(\$ 17,000\) cash. d. Sale of the truck for \(\$ 10,000\) cash. e. Theft of the truck. Crystal carries no insurance for theft.

Depreciation Methods A machine costing \(\$ 180,000\) was purchased May 1. The machine should be obsolete after four years and, therefore, no longer useful to the company. The estimated salvage value is \(\$ 15,000\). Calculate the depreciation expense for each year of its expected useful life using each of the following depreciation methods: (a) straight-line, (b) double-declining balance.

Journal Entries for Plant Assets During the first few days of the year, Coastal Company entered into the following transactions: 1\. Purchased a parcel of land with a building on it for \(\$ 3,500,000\) cash. The building, which will be used in operations, has an estimated useful life of 30 years and a salvage value of \(\$ 200,000\). The assessed valuations for property tax purposes show the land at \(\$ 280,000\) and the building at \(\$ 2,520,000\). 2\. Paid \(\$ 180,000\) for the construction of an asphalt parking lot for customers. The parking lot is expected to last 15 years and has no salvage value. 3\. Paid \(\$ 500,000\) for the construction of a new entrance to the building. 4\. Purchased store equipment, paying the invoice price (including seven percent sales tax) of \(\$ 89,660\) in cash. The estimated useful life of the equipment is five years, and the salvage value is \(\$ 4,000\). 5\. Paid \(\$ 640\) freight on the new equipment. 6\. Paid \(\$ 1,200\) to repair damages to floor caused when the store equipment was accidentally dropped as it was moved into place. 7\. Paid \(\$ 50\) for an umbrella holder to place inside front door (customers may place wet umbrellas in the holder). The holder is expected to last 30 years. Required a. Prepare journal entries to record these transactions. b. Prepare the December 31 journal entries to record depreciation expense for the year. Double declining balance depreciation is used for the equipment, and straight-line depreciation is used for the building and parking lot.

Foss Company bought land with a vacant building for \(\$ 400,000\). Foss will use the building in its operations. Must Foss allocate the purchase price between the land and building? Why or why not? Would your answer be different if Foss intends to raze the building and build a new one? Why or why not?
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