Question

1. Explain the concept of capitalization or capitalized? Include what type of costs might be included ? 3


2. Explain the concept of depreciation? 5

3. Describe the 3 months of depreciation and provide 3 examples of industries that might use each method? 5


4. Charles Inc. manufactures beauty supply equipment A review of its books for October revealed the following 5
cost of equipment 500,000
useful life+ 1o years
residual at the end of service life 75,000.
Total hours to be run on equipment 125,000
Year 1 + 7,000 hours
year 2= 10,000 hours
Given the above what is accumulated depreciation at the end of year 2 for each method.

5.
a. What is the difference between a long and short term asset. 1



b. What is the difference between an tangible and intangible asset? 1

Answer 1

(Answer 1)

Definition of capitalization:

An item is capitalized when it is recorded as an asset, rather than an expense. This means that the expenditure will appear in the balance sheet, rather than the income statement. You would normally capitalize an expenditure when it meets both of these criteria:

Exceeds capitalization limit- Companies set a capitalization limit, below which expenditures are deemed too immaterial to capitalize. The materiality principle applies to the capitalization concept.

Useful life of asset - If an expenditure is expected to help the company generate revenues for a long period of time, then you should record it as an asset and then depreciate it over its useful life, which agrees with the matching principle.

Value of cost to be capitalized:

Typical examples of costs are expenses associated with constructing a fixed asset and can include materials, sales taxes, labour, transportation, and interest incurred to finance the construction of the asset. Expenses associated with intangible assets can also be capitalized like trademarks, filing and defending of patents, and software development.

(Answer 2)

Depreciation:

Depreciation is a term applicable in case of plant, building, equipment, machinery, furniture, fixtures, vehicles, tools etc. These long-term or fixed assets have a limited useful life, i.e. they will provide service to the entity (in the form of helping in the generation of revenue) over a limited number of future accounting periods. Depreciation

implies gradual decrease in the value of an asset due to normal wear and tear, obsolescence etc. It makes a part of the cost of assets chargeable

as an expense in profit and loss account of the accounting periods in which the assets helped in earning revenue.

Causes of Depreciation

A. Internal Causes

(i) Wear and tear : Plant & machinery, furniture, motor vehicles etc. suffer from loss of utility due to vibration.

(ii) Depletion (or exhaustion) : The utility or resources of wasting assets (like mines etc.) decreases with regular extractions.

B. External or Economic Causes

(i) Obsolescence : Innovation of better substitutes, change in market demand, imposition of legal restrictions may result into discarding an asset.

(ii) Inadequacy : Changes in the scale of production or volume of activities may lead to discarding an

asset.

C. Time element : With the passage of time some intangible fixed assets like lease, patents, copy-rights etc lose their value or effectiveness.

(Answer 3)

Method of Depreciation:

Time Based Method

(i) Fixed Installment Method:

(i) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation.

(ii) Such depreciation becomes an equal amount in each period.

(iii) The formula for calculation of depreciation is : Depreciation = (V-S)/n

Where,

V = Cost of the asset

S = Residual value or the expected scrap value of the asset

n = Estimated life of the asset

(ii) Reducing Balance Method:

(i) Depreciation is calculated at a fixed percentage on the original cost in the first year. But in subsequent years it is calculated at the same percentage on the written down values gradually reducing during the expected working life of the asset.

(ii) The rate of allocation is constant (usually a fixed percentage) but the amount allocated for every year gradually decreases.

Activity Based Method

(i) Use Base method

The use Base method of depreciation depreciates assets based on the total number of hours used or the total number of units to be produced by using the asset, over its useful life.

Industries using these method:

(i) Fixed installment method- Furniture industries

(ii) Reducing balance method- Automotive industries

(iiI) Use Base Method- Manufacturing industries

(Answer 4)

Accumulated depreciation at the end of year 2

*Straight line method:

Value of the asset=5,00,000

Useful life=10 years

Salvage value=75,000

Depreciation=Value of asset - salvage value/No of years

=5,00,000-75,000/10

=425000/10

=42,500

Total depreciation =42500*2

                            = 85,000

*Use Base method

Total hours available= 1,25,00

Hours used in 2 years =17,000

Depreciation=(Value of asset - salvage value)*House utilized/Total hours

=(5,00,000-75,000)*17,000/1,25,000

=57,800

(Answer 5)

Difference between Short term and long-term assets

Current assets or short term assets can be converted into cash within one fiscal year or one operating cycle. Current assets are used to facilitate day-to-day operational expenses and investments.

Examples of current assets include:

Cash and cash equivalents, which might consist of certificates of deposit

Marketable securities such as equity or debt securities

Accounts receivable

Fixed assets or long term assets are those assets that a company uses in its production or goods and services that have a life of more than one year.

Examples of fixed assets include:

Machinery

Buildings

Land

(Answer 5

(b)

Difference between tangible and intangible assets

A tangible asset is something that is owned by an individual or organization utilized for conducting business activities over a long period of time. Intangible assets are those which have an economic value and a certain life. These are considered as earned over the hard work executed over a long period of time.

Tangible assets can be converted into cash since it can be viewed to the eye and can be weighed in monetary terms whereas intangible assets are difficult to convert into cash on an immediate basis.