CAPITAL

EXPENDITURE
AND DEPRECIATION
Capital Expenditure (CAPEX)
• Capex or expenses are depreciated or amortized over the years. For example, it can buy
equipment/ buildings or add value to an existing asset to upgrade beyond the current
financial year.
• Once the asset is put to use, it depreciates over a period to spread the asset’s cost over its
useful span of life. Every year, a part of the asset is put to use.
• Depreciation is the amount of depletion on the fixed asset, and the amount of depreciation
that happens each year is used as a tax deduction.
• Capital expenses are mostly depreciated over a five to ten years period but sometimes may
be depreciated over twenty years in the case of real estate properties.
• Capital expenditure is therefore used for future benefits like the company’s growth.
Operating Expenditure (OPEX)

• Opex refers to those expenses that a business has to incur to run its daily operations. For
example, the employees’ wages, leases, maintenance and repair cost, etc.
• Opex is entirely tax-deductible. Therefore it is more attractive for a company to lease an
item and assign its cost to operating expenses rather than purchase it.
• It can be a financially attractive option for the company if it has limited cash flow.
 Plant Assets, Natural Resources, and
Intangible Assets

Statement
Natural Intangible
Plant Assets Presentation and
Resources Assets
Analysis

Determining the Accounting for Accounting for Presentation

cost of plant extractable intangibles Analysis
assets natural resources Types of
Depreciation Financial intangibles
Revaluation of statement Research and
plant assets presentation development
Expenditures costs
during useful life
Plant asset
disposals
Section 1 – Plant Assets
Plant assets include land, land improvements, buildings,
and equipment (machinery, furniture, tools).
Major characteristics include:

“Used in operations” and not for resale.

Long-term in nature and usually depreciated.
Possess physical substance.

Referred to as property, plant, and equipment; plant and

equipment; and fixed assets.
Section 1 – Plant Assets
Illustration 9-1
Percentages of plant assets
in relation to total assets
Determining the Cost of
Plant Assets
Land
Includes all costs to acquire land and ready it for use.
Costs typically include:
(1) purchase price;
(2) closing costs, such as title and attorney’s fees;
(3) real estate brokers’ commissions;
(4) costs of grading, filling, draining, and clearing;
(5) assumption of any liens, mortgages, or encumbrances
on the property.
Determining the Cost of
Plant Assets
Illustration: Assume that Hayes Manufacturing Company
acquires real estate at a cash cost of $100,000. The property
contains an old warehouse that is razed at a net cost of $6,000
($7,500 in costs less $1,500 proceeds from salvaged materials).
Additional expenditures are the attorney’s fee, $1,000, and the
real estate broker’s commission, $8,000. The cost of the land is
$115,000, computed as follows.

Required: What is cost of the land.

Determining the Cost of
Plant Assets
Required: Determine amount to be reported as the cost of the
land.
Land

Cash price of property of $100,000 $100,000

Net removal cost of warehouse of $6,000 6,000
Attorney's fees of $1,000 1,000
Real estate broker’s commission of $8,000 8,000
Cost of Land $115,000
Determining the Cost of
Plant Assets
Land Improvements
All expenditures necessary to make the improvements
ready for their intended use.

Driveways, parking lots, fences, landscaping, and

underground sprinklers.
Limited useful lives.
Expense (depreciate) the cost of land improvements
over their useful lives.
Determining the Cost of
Plant Assets
Buildings
All costs related directly to purchase or construction.
Purchase costs:
Purchase price, closing costs and real estate broker’s
commission.
Remodeling and replacing or repairing the roof, floors,
electrical wiring, and plumbing.

Construction costs:
Contract price plus payments for architects’ fees, building
permits, and excavation costs.
Determining the Cost of
Plant Assets
Equipment
All costs incurred in acquiring the equipment and
preparing it for use.
Costs typically include:
purchase price,
sales taxes,
freight and handling charges,
insurance on the equipment while in transit,
assembling and installation costs, and
costs of conducting trial runs.
Determining the Cost of
Plant Assets
Illustration: Assume Merten Company purchases factory
machinery at a cash price of $50,000. Related expenditures are
for sales taxes $3,000, insurance during shipping $500, and
installation and testing $1,000. Determine amount to be
reported as the cost of the machinery.
Machinery
Cash price $50,000
Sales taxes 3,000
Insurance during shipping 500
Installation and testing 1,000
Cost of Machinery $54,500
Depreciation
Depreciation is the process of allocating the cost of tangible assets
to expense in a systematic and rational manner to those periods
expected to benefit from the use of the asset.

Process of cost allocation, not asset valuation.

Applies to land improvements, buildings, and equipment, not land.
Depreciable, because the revenue-producing ability of asset will
decline over the asset’s useful life.

Allocating costs of long-term assets:

◆ Fixed assets = Depreciation expense

◆ Intangibles = Amortization expense

◆ Natural resources = Depletion expense

Depreciation
Factors in Computing Depreciation

Cost Useful Life Residual Value

Depreciation - Method of
Cost Allocation
Factors Involved in the Depreciation Process
Three basic questions:

(1) What depreciable base is to be used?

(2) What is the asset’s useful life?

(3) What method of cost allocation is best?

Depreciation - Method of
Cost Allocation
Factors Involved in the Depreciation Process
Depreciable Base
Depreciation - Method of
Cost Allocation
Factors Involved in the Depreciation Process
Estimation of Service Lifes

◆ Service life often differs from physical life.

◆ Companies retire assets for two reasons:

1. Physical factors (casualty or expiration of

physical life).

2. Economic factors (inadequacy, supersession,

and obsolescence).
Depreciation - Method of
Cost Allocation
Methods of Depreciation
The profession requires the method employed be “systematic
and rational.” Examples include:
(1) Activity method (units of use or production).

(2) Straight-line method.

(3) Sum-of-the-years’-digits.
Accelerated methods
(4) Declining-balance method.

(5) Group and composite methods.

Special methods
(6) Hybrid or combination methods.
Depreciation
Depreciation Methods
Objective is to select the method that best measures an
asset’s contribution to revenue over its useful life.

Examples include:
(1) Straight-line method.
(2) Units-of-Activity method.
(3) Declining-balance method.
Depreciation
Illustration: Barb’s Florists purchased a small delivery truck on
January 1, 2011.

Required: Compute depreciation using the following.

(a) Straight-Line (b) Units-of-Activity (c) Declining Balance.
Depreciation
Straight-Line
Expense is same amount for each year.
Depreciable cost - cost of the asset less its residual
value.
Depreciation
Illustration: (Straight-Line Method)
Depreciable Annual Accum. Book
Year Cost x Rate = Expense Deprec. Value
2011 $ 12,000 20% $ 2,400 $ 2,400 $ 10,600
2012 12,000 20 2,400 4,800 8,200
2013 12,000 20 2,400 7,200 5,800
2014 12,000 20 2,400 9,600 3,400
2015 12,000 20 2,400 12,000 1,000
Depreciation
Units-of-Activity
Companies estimate total units of activity to calculate
depreciation cost per unit.
Expense varies based on units of activity.
Depreciable cost is
cost less residual
value.
Depreciation
Illustration: (Units-of-Activity Method)
Units Annual
of Cost / Depreciation Accumulated Book
Year Activity x Unit = Expense Depreciation Value

2011 15,000 $ 0.12 $ 1,800 $ 1,800 $ 11,200

2012 30,000 0.12 3,600 5,400 7,600
2013 20,000 0.12 2,400 7,800 5,200
2014 25,000 0.12 3,000 10,800 2,200
2015 10,000 0.12 1,200 12,000 1,000
Depreciation
Declining-Balance

Decreasing annual depreciation expense over the asset’s

useful life.
Declining-balance rate is double the straight-line rate.
Rate applied to book value.
Depreciation
Illustration: (Declining-Balance Method)
Declining Annual
Beginning Balance Deprec. Accum. Book
Year Book value x Rate = Expense Deprec. Value

2011 13,000 40% $ 5,200 $ 5,200 $ 7,800

2012 7,800 40 3,120 8,320 4,680
2013 4,680 40 1,872 10,192 2,808
2014 2,808 40 1,123 11,315 1,685
2015 1,685 40 685* 12,000 1,000

* Computation of $674 ($1,685 x 40%) is adjusted to $685.

Depreciation
Comparison of Methods
Expenditures During Useful
Life
Ordinary Repairs - expenditures to maintain the operating
efficiency and productive life of the unit.
Debit - Repair (or Maintenance) Expense.
Referred to as operating expenditures.
Example : motor tune up and oil changes, etc
Additions and Improvements - costs incurred to increase
the operating efficiency, productive capacity, or useful life of a
plant asset.
Debit - the plant asset affected.
Referred to as capital expenditures.
Plant Asset Disposals
Companies dispose of plant assets in three ways —
Retirement, Sale, or Exchange (appendix).

Record depreciation up to the date of disposal.

Eliminate asset by (1) debiting Accumulated Depreciation, and
(2) crediting the asset account.
Plant Asset Disposals
Sale of Plant Assets
Compare the book value of the asset with the proceeds
received from the sale.
If proceeds exceed the book value, a gain on disposal
occurs.

If proceeds are less than the book value, a loss on

disposal occurs.
Exchange of Plant Assets

Ordinarily, companies record a gain or loss on the

exchange of plant assets.

The rationale for recognizing a gain or loss is that

most exchanges have commercial substance.

An exchange has commercial substance if the

future cash flows change as a result of the
exchange.
 Exchange of Plant Assets
Illustration: Roland Co. exchanged old trucks (cost $64,000
less $22,000 accumulated depreciation) plus cash of $17,000
for a new semi-truck. The old trucks had a fair value of
$26,000.

Cost of old trucks $64,000

Loss Less: Accumulated depreciation 22,000
Treatment Book value 42,000
Fair value of old trucks 26,000
Loss on disposal $16,000

Fair value of old trucks $26,000

Cash paid 17,000
Cost of new semi-truck $43,000
 Exchange of Plant Assets
Illustration: Mark Express Delivery trades its old delivery
equipment (cost $40,000 less $28,000 accumulated
depreciation) for new delivery equipment. The old equipment
had a fair value of $19,000. Mark also paid $3,000.

Cost of old equipment $40,000

Gain Less: Accumulated depreciation 28,000
Treatment Book value 12,000
Fair value of old equipment 19,000
Gain on disposal $ 7,000

Fair value of old equipment $19,000

Cash paid 3,000
Cost of new equipment $22,000
Section 2 – Natural Resources

Natural resources consist of standing timber and

resources extracted from the ground, such as oil, gas,
and minerals.
Standing timber is considered a biological asset under
IFRS.
In the years before they are harvested, the recorded
value of biological assets is adjusted to fair value each
period.
Section 2 – Natural Resources
IFRS defines extractive industries as those businesses
involved in finding and removing natural resources located in
or near the earth’s crust.
Cost - price needed to acquire the resource and prepare it for
its intended use.
Depletion - allocation of the cost to expense in a rational and
systematic manner over the resource’s useful life.
Depletion is to natural resources as depreciation is to plant
assets.
Companies generally use units-of-activity method.
Depletion generally is a function of the units extracted.
Section 3 – Intangible Assets
Intangible assets are rights, privileges, and competitive
advantages that do not possess physical substance.

Intangible assets are categorized as having either a

limited life or an indefinite life.
Common types of intangibles:

Patents Trademarks and trade

Copyrights names
Franchises or licenses Goodwill

IFRS permits revaluation of intangible assets to fair value, except for goodwill.
Types of Intangible Assets
Patents
Exclusive right to manufacture, sell, or otherwise control
an invention for a specified number of years from the
date of the grant.

Legal life in many countries is 20 years.

Capitalize costs of purchasing a patent and amortize

over its legal life or its useful life, whichever is shorter.

Legal fees incurred successfully defending a patent are

capitalized to Patent account.
Accounting for Intangible
Assets
Intangible assets are typically amortized on a straight-line
basis.

Illustration: Assume that National Labs purchases a patent at

a cost of $60,000. National estimates the useful life of the
patent to be eight years. National records the annual
amortization as follows.

Amortization expense 7,500

Patent 7,500
Accounting for Intangible
Assets
Copyrights
Give the owner the exclusive right to reproduce and sell
an artistic or published work.
➢ plays, literary works, musical works, pictures,
photographs, and video and audiovisual material.
Granted for the life of the creator plus a specified number
of years, which can vary by country but is commonly 70
years.
Capitalize costs of acquiring and defending it.
Amortized to expense over useful life.
Accounting for Intangible
Assets
Trademarks and Trade Names
Word, phrase, jingle, or symbol that identifies a particular
enterprise or product.
➢ Wheaties, Game Boy, Frappuccino, Kleenex,
Windows, Coca-Cola, and Jetta.
Registration provides a specified number of years of
protection, which can vary by country, but is commonly 20
years.
Capitalize acquisition costs.
Renewed indefinitely, no amortization.
Accounting for Intangible
Assets
Franchises and Licenses
Contractual arrangement between a franchisor and a
franchisee.

➢ BP (GBR), Taco Bell (USA), or Rent-A-Wreck (USA)

are franchises.

Franchise (or license) with a limited life should be

amortized to expense over the life of the franchise.

Franchise with an indefinite life should be carried at cost

and not amortized.
Accounting for Intangible
Assets
Goodwill
Includes exceptional management, desirable location, good
customer relations, skilled employees, high-quality products,
etc.

Only recorded when an entire business is purchased.

Goodwill is recorded as the excess of ...

purchase price over the fair value of the identifiable net
assets acquired.
Internally created goodwill should not be capitalized.
Research and
Development Costs
Frequently results in something that a company patents
or copyrights such as:

new product, formula,

process, composition, or
idea, literary work.

➢ Costs in the research phase are always expensed as

incurred.
➢ Costs in the development phase are expensed until
specific criteria are met, primarily that technological
feasibility is achieved.
Statement Presentation
and Analysis
Presentation
DEPRECIATION UNDER MACRS

• Under the basic MACRS procedures, the depreciable value of an asset is its full cost, including
outlays for installation.
• No adjustment is required for expected salvage value.
• For tax purposes, the depreciable life of an asset is determined by its MACRS recovery
predetermined period.
• MACRS property classes and rates are shown in
Table 4.1 and Table 4.2 on the following slides.
TABLE 4.1 FIRST FOUR PROPERTY
CLASSES UNDER MACRS
TABLE 4.2 ROUNDED DEPRECIATION PERCENTAGES BY RECOVERY YEAR USING MACRS
FOR FIRST FOUR PROPERTY CLASSES
DEPRECIATION: AN EXAMPLE
• Baker Corporation acquired, for an installed cost of $40,000, a machine
having a recovery period of 5 years. Using the applicable MACRS rates, the
depreciation expense each year is as follows: