Analyzing Investing Activities

The Balance Sheet

Old accountants never die;

they just lose their balance
--Anonymous

2-2

Copyright 2010 Pearson

Education, Inc. Publishing as

Assets
Classification
Current
Current (Short(Shortterm)
term) Assets
Assets
Resources
Resources or
or claims
claims
to
to resources
resources that
that are
are
expected
expected to
to be
be sold,
sold,
collected,
collected, or
or used
used
within
within one
one year
year or
or
the
the operating
operating cycle,
cycle,
whichever
whichever is
is longer.
longer.

Noncurrent
Noncurrent
(Long-term)
(Long-term)
Assets
Assets
Resources
Resources or
or claims
claims
to
to resources
resources that
that
are
are expected
expected to
to
yield
yield benefits
benefits that
that
extend
extend beyond
beyond one
one
year
year or
or the
the
operating
operating cycle,
cycle,
whichever
whichever is
is longer.
longer.

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

2-5

TURKCELL

Property, plant and equipment

Intangible assets
GSM and other telecommunication
operating licenses
Computer software
Other intangible assets
Investments in equity accounted investees
Other investments
Due from Related parties
Other non-current assets
Trade receivables
Deferred tax assets
Total non-current assets
Inventories
Other investments
Due from related parties

$ 000
2010
2009
3,068,0 2,652,2
21
22
1,709,3 1,897,9
11
81
955.70 1,058,0
3
98
547.60 595.21
7
8
206.00 244.66
1
5
399.62
2 383.49
33.849 34.755
1.044 21.039
107.27
7 75.12
35.0242.876 2.058
5,357,0 5,066,6
24
65
24.386 28.205
8.201 62.398
108.84
88.897
3

Common Size
2010
2009
31.32% 28.45%
17.45% 20.36%
0.01% 11.35%
0.01%

0.01%

0.00%

0.00%

0.00%
0.00%
0.00%

0.00%
0.00%
0.00%

0.00% 0.00%
0.00%
0.00% 0.00%
54.69% 54.36%
0.00% 0.00%
0.00% 0.00%
0.00%

0.00%

ARCELIK

$ 000
2010

Common Size
2009

2010

2009

Donen varliklar:
Nakit ve nakit benzerleri
Trev finansal aralar
Ticari alacaklar
Stoklar
Diger dnen varliklar
Toplam donen varliklar
Duran varliklar:
Ticari alacaklar
Finansal yatirimlar
zkaynak yntemiyle degerlenen
yatirimlar
Yatirim amali gayrimenkuller
Maddi duran varliklar
Maddi olmayan duran varliklar
Serefiye
Ertelenen vergi varliklar

1,317,1
66 904,734
1,185 4,444
2,324,5 2,233,0
78
11
987,526 906,786
117,984 108,980
4,748,4 4,157,9
39
55
12,461 4,254
658,679 395,814

17.99% 14.08%
0.02% 0.07%
31.75% 34.75%
13.49% 14.11%
1.61% 1.70%
64.85% 64.70%
0.00%
0.17%
9.00%

0.00%
0.07%
6.16%

136,604 129,169 1.87% 2.01%

5,480 6,344 0.07% 0.10%
1,252,2 1,244,1
45
09 17.10% 19.36%
461,417 439,993 6.30% 6.85%
7,190 7,511 0.10% 0.12%
39,244 41,509 0.54% 0.65%

Current Assets
Operating cycle
Time required to purchase or manufacture
inventory, sell the product, and collect the
cash
Working capital
Also called net working capital
Current assets less current liabilities

2-8

Copyright 2010 Pearson Education, Inc. Publishing as

Prentice Hall

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.
045%
040%
035%
030%
025%
020%
015%
010%
005%
000%
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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
035%
030%
025%
020%
015%
010%
005%
000%
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Valuation of Receivables
Receivables
Receivables are
are reported
reported at
at their
their net
net
realizable
realizable value
value
total
total amount
amount of
of
receivables
receivables less
less an
an allowance
allowance for
for
uncollectible
uncollectible accounts
accounts
Management
Management estimates
estimates the
the allowance
allowance
for
for uncollectibles
uncollectibles based
based on
on experience,
experience,
customer
customer fortunes,
fortunes, economy
economy and
and
industry
industry expectations,
expectations, and
and collection
collection
policies
policies

TURKCELL
Allowance for doubtful receivables
During 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 managements 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 Groups 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 estimate127,921
Current accounting estimate 126,257
Impact 1,664
Due to the impracticability, the Group has not disclosed the effect of the change for the future periods.

Arcelik

Analyzing Receivables
Assessment
Assessmentof
ofearnings
earningsquality
qualityis
isoften
oftenaffected
affectedby
byan
ananalysis
analysisof
of
receivables
and
their
collectibility
receivables and their collectibility
Analysis
Analysismust
mustbe
bealert
alertto
tochanges
changesin
inthe
theallowancecomputed
allowancecomputedrelative
relativeto
to
sales,
receivables,
or
industry
and
market
conditions.
sales, receivables, or industry and market conditions.
Two
Twospecial
specialanalysis
analysisquestions:
questions:
(1)
(1) Collection
Collection Risk
Risk
Review
Reviewallowance
allowancefor
foruncollectibles
uncollectiblesin
inlight
lightof
ofindustry
industryconditions
conditions
Apply
Applyspecial
specialtools
toolsfor
foranalyzing
analyzingcollectibility:
collectibility:
Determining
Determiningcompetitors
competitorsreceivables
receivablesas
asaapercent
percentof
ofsalesvis-salesvis-vis
the
company
under
analysis
vis the
company under analysis
Examining
customer
Examining customerconcentrationrisk
concentrationriskincreases
increaseswhen
when
receivables
are
concentrated
in
one
or
a
few
customers
receivables are
concentrated in one or a few customers
Investigating
Investigatingthe
theage
agepattern
patternof
ofreceivablesoverdue
receivablesoverdueand
andfor
forhow
how
long
long
Determining
Determiningportion
portionof
ofreceivables
receivablesthat
thatis
isaarenewal
renewalof
ofprior
prior
receivables
receivables
Analyzing
Analyzingadequacy
adequacyof
ofallowances
allowancesfor
fordiscounts,
discounts,returns,
returns,and
andother
other
credits
credits
(2)
(2) Authenticity
Authenticity of
of Receivables
Receivables
Review
Reviewcredit
creditpolicy
policyfor
forchanges
changes
Review
return
policies
for
Review return policies forchanges
changes
Review
any
contingencies
on
Review any contingencies onreceivables
receivables

Receivables are Carried at Amortized Cost

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

2-15

(C) 2007 Prentice Hall, Inc.

Illustration
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
1/ n
is:
FV

i=
1 /( 90 / 360 )
1
PV
52,000
i
1 17%

FV Future value
50,000
PV = Present Value
n = days to maturity
i = effective interest rate

2-16

(C) 2007 Prentice Hall, Inc.

Present Value of 52,000

at the end of the year
30 days remain to
payment day

52.000
PV
51.325
30 / 360
(1 0,17)

2-17 (C) 2007 Prentice Hall,

Inc.

Securitization of
Receivables
Securitization
factoring)
Securitization (or
(or
factoring) is
is when
when aa company
company sells
sells all
all
or
or aa portion
portion of
of its
its receivables
receivables to
to aa third
third party
party
Receivables
Receivables can
can be
be sold
sold with
with or
or without
without recourse
recourse to
to aa
buyer
buyer (recourse
(recourse refers
refers to
to guarantee
guarantee of
of collectibility)
collectibility)
Sale
Sale of
of receivables
receivables with
with recourse
recourse does
does not
not effectively
effectively
transfer
transfer risk
risk of
of ownership
ownership

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 companys 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
030%
from their sale
025%
020%
015%
010%
005%
000%
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Inventory Costing Method

Use of Inventory Methods in Practice

Cost Flow of Inventories

First-In, First-Out
(FIFO)
Oldest
Oldest
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Recent
Recent
Costs
Costs

Ending
Ending
Inventory
Inventory

Cost Flow of Inventories

Last-In, First-Out
(LIFO)

Recent
Recent
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Oldest
Oldest
Costs
Costs

Ending
Ending
Inventory
Inventory

Average Cost
When
When aa unit
unit is
is sold,
sold, the
the average
average cost
cost of
of
each
each unit
unit in
in inventory
inventory is
is assigned
assigned to
to
cost
cost of
of goods
goods sold.
sold.
Cost of
Goods
Available
for Sale

Units
available
on the
date of
sale

Inventory Accounting Methods

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

2-24

(C) 2007 Prentice Hall, Inc.

Illustration of Costing Methods

Inventory
Inventory on
on January
January 1,
1, Year
Year 22 40
40 @
@ $500
$500 $$
20,000
20,000
Inventories
Inventories purchased
purchased
during
60
during the
the year
year
60 @
@ $600
$600
36,000
36,000
Cost
Cost of
of Goods
Goods available
available
for
100
for sale
sale
100 units
units $$ 56,000
56,000
Note:
Note: 30
30 units
units are
are sold
sold in
in Year
Year 22 for
for $800
$800 each
each
for
for total
total Revenue
Revenue of
of $24,000
$24,000

Illustration of Costing Methods

Beginning
Net
Cost
Beginning
Net
Costof
of
Inventory
Inventory +
+ Purchases
Purchases=
= Goods
GoodsSold
Sold +
+

Ending
Ending

Inventory
Inventory
FIFO
$20,000
+
=
+
FIFO
$20,000
+ $36,000
$36,000
= $15,000
$15,000
+ $41,000
$41,000
LIFO
$20,000
+
=
+
LIFO
$20,000
+ $36,000
$36,000
= $18,000
$18,000
+ $38,000
$38,000
Average
$20,000
+
=
+
Average
$20,000
+ $36,000
$36,000
= $16,800
$16,800
+ $39,200
$39,200

Assume
Assumesales
salesof
of$35,000
$35,000for
forthe
theperiodthen
periodthengross
grossprofit
profitunder
under
each
eachmethod
methodis:
is:
Sales
Cost
Gross
Sales
Costof
ofGoods
GoodsSold
Sold =
=
GrossProfit
Profit
FIFO
$24,000
---- 15,000
=
$9,000
FIFO
$24,000
15,000
=
$9,000
LIFO
$24,000
---- 18,000
=
$6,000
LIFO
$24,000
18,000
=
$6,000
Average
---- 16,800
=
$7,200
Average $24,000
$24,000
16,800
=
$7,200

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 FIFOs 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

Other current assets

Prepaid Expenses
Prepaid
Prepaid expenses
expenses are
are advance
advance payments
payments for
for services
services or
or
goods
goods not
not yet
yet received
received that
that extend
extend beyond
beyond the
the current
current
accounting
accounting periodexamples
periodexamples are
are advance
advance payments
payments for
for
rent,
rent, insurance,
insurance, utilities,
utilities, and
and property
property taxes
taxes

Analysis of
Two analysis issues: Prepaids
Two analysis issues:

(1)
(1)For
For reasons
reasons of
of expediency,
expediency, noncurrent
noncurrent prepaids
prepaids
sometimes
sometimes are
are included
included among
among prepaid
prepaid expenses
expenses
classified
classified as
as current--when
current--when their
their magnitude
magnitude is
is
large,
they
warrant
scrutiny
large, they warrant scrutiny
(2)
(2) Any
Any substantial
substantial changes
changes in
in prepaid
prepaid expenses
expenses
warrant
warrant scrutiny
scrutiny

Accounting for Debt and Equity Investments

Debt
Short term
Valuation
Method

(trading
securities)
Fair Value
(Market
Value)

Long term
Held for resale*

Held to maturity

Fair market value

Amortized Cost

Stocks
Long term

Valuation
Method

Short term
(trading
securities)

Fair Value
(Market
Value)
29

Ownership percentage
Greater than

0 20% of the investee

shares*

20-50%
of the
investee
shares

50% of the investee

shares

Fair Value (Market

Value)

Equity
Method

Consolidation

Mugan-Akman 2010

Chapter 9

* usually classified as available for sale investments

Types of Investments-Stocks
The accounting for investments depends on the purpose of the
investment and the percentage of voting stock held.
Investor
InvestorCorporation
Corporation

Minority,
Minority,Passive
Passive
Investments
Investments(less
(lessthan
than
20%
20%ownership)
ownership)
held
heldas
as
held
heldasas
current
assets,
current assets, long-term
long-term
marketable
Investmentsmarketable
InvestmentsSecurities
Available
Securities Availablefor
forsale
sale
Trading
Tradingsec
sec
30

Minority,
Minority,Active
Active
Investments
Investments(typically
(typically
between
between20%
20%and
and
50%
50%ownership)
ownership)

Equity
Equitymethod
method
of
ofaccounting
accounting
Mugan-Akman 2010

Majority,
Majority,Active
Active
Investments
Investments
(greater
(greaterthan
than
50%
50%ownership)
ownership)
acquired
acquiredinin
PurchasePurchaseconsolidation
consolidation
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 Mugan-Akman
held to maturityusually
31
2010 Chapter 9
classified as long term investments.

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.
32

Mugan-Akman 2010

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

33

Mugan-Akman 2010

Chapter 9

Adjusting Entries-Trading Securities

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

34

Mugan-Akman 2010

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

35

Mugan-Akman 2010

Chapter 9

Available for Sale Securities

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

36

Mugan-Akman 2010

Chapter 9

Comparison - trading and available for sale

securities

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
010%
009%
008%
007%
006%
005%
004%
003%
002%
001%
000%
arcelik

37

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Mugan-Akman 2010

Chapter 9

Long term assets

Long-term
Long-term assetsresources
assetsresources that
that are
are used
used to
to generate
generate
revenues
revenues (or
(or reduce
reduce costs)
costs) in
in the
the long
long run
run
Financial assets such as available for sale;
equity method investments
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

Allocation of initial costs to respective periods

Allocationprocess
Allocationprocess of
of periodically
periodically expensing
expensing aa
deferred
deferred cost
cost (asset)
(asset) to
to one
one or
or more
more future
future
expected
expected benefit
benefit periods;
periods; determined
determined by
by benefit
benefit
period,
period, salvage
salvage value,
value, and
and allocation
allocation method
method
Terminology
Terminology
Depreciation
Depreciation for
for tangible
tangible fixed
fixed
assets
assets
Amortization
Amortization for
for intangible
intangible assets
assets

Depletion
Depletion for
for natural
natural resources
resources

Acquisition cost of PPE

Purchas
e
price

Acquisition
cost

Acquisition cost
excludes financing
charges (except in self
constructed assets) and
cash discounts

All
expenditur
es needed
to prepare
the asset
for its
intended
use

Property, Plant, and Equipment

(PP&E)

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.
2-41

Copyright 2010 Pearson

Education, Inc. Publishing as

Property, Plant, and Equipment (PP&E)

060%

Proportion of fixed assets in a companys asset

structure is determined by nature of the
business.
Fixed assets are most prominent at the
manufacturing
operating assets level.
intangibles
030%

050%

025%

040%

020%

030%
020%

015%

010%

010%

000%

005%
000%
arcelik

2-42

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Education, Inc. Publishing as

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Depreciation
Depreciation is the process of
allocating the cost of a plant asset to
expense in the accounting periods
benefiting from its use.
Stat of Fin Position
Acquisition
Cost
(Unused
)

Income Statement
Expense
Cost
Allocatio
n

(Used
)

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

Straight-Line Method

Depreciation
Expense per Year =

Cost - Salvage
Value
Useful life in periods

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

Double-Declining-Balance Method

Step 1:
Straight-line
depreciation rate
Step 2:
Double-decliningbalance rate

100 %
Useful life

Straight-line
depreciation rate

Step 3:
Depreciation
Double-decliningBeginning period
=

expense
balance rate
book value
Ignores salvage
value

Activity (Units-of-Production) Method

Step 1:
Depreciation = Cost - Salvage Value
Per Unit
Total Units of Production
Step 2:
Depreciation
Expense

Depreciation
=

Per Unit

Units
Produced
in Period

Depreciation Methods-comparison
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 assets 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 % SL
companies

19982006

48591

% ACC

79,53 20,47

Economic consequences of firms depreciation method ch

a,
ScottEvidence
B. Jacksonfrom
oice:
capital investments
Xiaotao (Kelvin) Liub,
Mark Cecchinia

2-48

Copyright 2010 Pearson

Education, Inc. Publishing as

SIC code description

Metal mining
Oil and gas extraction

% SL %
ACC

SIC code description

% SL %
ACC

10.8
9
17.3
9

Transportation equipment

74.7
5
82.0
7

89.1
1
82.6
1

Building construction general contractors 79.3 20.6

7

86.0
5
84.7
Textile mill products
5
Apparel and other finished products made 77.8
8
from fabrics

13.9
5
15.2
5
22.1
2

80.6
0
63.2
5
81.7
5

19.4
0
36.7
5
18.2
5

84.7
8
38.8
9
79.8
3

15.2
2
61.1
1
20.1
7

Food and kindred products

Furniture and fixtures

Paper and allied products
Printing, publishing, and allied industries
Chemicals and allied products
Petroleum refining and related industries

Rubber and miscellaneous plastics

products
Stone, clay, glass, and concrete products 66.2 33.7

Measuring, analyzing, and

controlling instruments
Miscellaneous manufacturing
industries
Wholesale trade durable goods
Wholesale trade non-durable goods
General merchandise stores
Food stores
Apparel and accessory stores
Home furniture, furnishings, and
equipment stores
Eating and drinking places
Miscellaneous retail
Business services
Motion pictures

2
8
76.1 23.8
Primary metal industries
Amusement and recreation services
9
1
81.5 18.4
Fabricated metal products
Health services
Economic consequences of firms depreciation method
8
2 choice: Evidence from capital investments
a
Scott B. Jackson Xiaotao (Kelvin) Liub,Mark Cecchini
Industrial
and commercial machinery and 81.7 18.2
Engineering, accounting,
5
5
a,

25.2
5
17.9
3

76.0 23.9
3
7
75.9
6
78.4
7
95.0
8

24.0
4
21.5
3
4.92

92.7 7.27
3
93.3 6.67
3
93.2 6.78
2
93.7
1
87.2
4
86.8
6

6.29

51.5
5
83.9
3
91.5
5
81.9
8

48.4
5
16.0
7
8.45

12.7
6
13.1
4

18.0
2

Capitalization
Capitalizationprocess
Capitalizationprocessof
ofdeferring
deferringaacost
costthat
thatis
isincurred
incurredin
in
the
thecurrent
currentperiod
periodand
andwhose
whosebenefits
benefitsare
areexpected
expectedto
toextend
extend
to
toone
oneor
ormore
morefuture
futureperiods
periods

For
Foraacost
costto
tobe
becapitalized,
capitalized,ititmust
mustmeet
meeteach
eachof
ofthe
the
following
followingcriteria:
criteria:
It
Itmust
mustarise
arisefrom
fromaapast
pasttransaction
transactionor
orevent
event
It
Itmust
mustyield
yieldidentifiable
identifiableand
andreasonably
reasonablyprobable
probablefuture
future
benefits
benefits
It
Itmust
mustallow
allowowner
owner(restrictive)
(restrictive)control
controlover
overfuture
future
benefits
benefits

Valuation of PPE
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
. Impairmentprocess

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.

2-51

(C) 2007 Prentice Hall, Inc.

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 companieseven 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

Natural Resources

Natural resources (wasting assets)rights to extract or consume

natural resources

Total cost,
including
exploration and
development,
is charged to
depletion expense
over periods
benefited.

Extracted from
the natural
environment
and reported
at cost less
accumulated
depletion.

Examples: oil, coal, gold

Depletion of Natural Resources

Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as
follows:
Cost Salvage
Value
Total Units of
Capacity

Depletion of Natural Resources

Total depletion cost for a period is:

Unit Depletion
Rate

Total
depletion
cost

Number of Units
Extracted in Period
If sold
Cost of goods sold
If not
Inventory

Analyzing Depreciation and Depletion

Assess reasonableness of depreciable

base, useful life, and allocation method
Review any revisions of useful lives
Evaluate adequacy of depreciationratio of depreciation to
total
assets or to other size-related
factors
Analyze plant asset agemeasures include
Average total life span
assets /
expense.
Average age
Current
Average remaining life
assets /
expense.
Average total life span
remaining life

= Gross plant and equipment

Current year depreciation
= Accumulated depreciation /
year depreciation expense.
= Net plant and equipment
Current year depreciation
=

Average age + Average

(these measures also reflect on profit margins and financing

Intangible
Assets
Often
Often provide
provide
exclusive
exclusive rights
rights
or
or privileges.
privileges.

Noncurrent
Noncurrent assets
assets
without
without physical
physical
substance.
substance.

Intangible
Assets
Useful
Useful life
life is
is
often
often difficult
difficult
to
to determine.
determine.

Usually
Usually acquired
acquired
for
for operational
operational
use.
use.

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
goodwilloften 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

Other Assets
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

2-60

Copyright 2010 Pearson

Education, Inc. Publishing as