Fixed Assets And Intangible Assets

Chapter 10 Fixed Assets and Intangible Assets Accounting, 21st Edition Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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Objectives Objectives 1. Define fixed assets and describe the accounting for their cost. After this After studying studying 2. Compute depreciation, using thethis following methods: chapter, you straight-line method, units-of-production chapter, you should should method, and declining-balance method. be able to: be able to: 3. Classify fixed asset costs as either capital expenditures or revenue expenditures. 4. Journalize entries for the disposal of fixed assets. 5. Define a lease and summarize the accounting rules related to the leasing of fixed assets.

Objectives Objectives 6. Describe internal controls over fixed assets. 7. Compute depletion and journalize the entry for depletion. 8. Describe the accounting for intangible assets, such as patents, copyrights, and goodwill. 9. Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. 10. Compute and interpret the ratio of fixed assets to long-term debt.

Nature Nature of of Fixed Fixed Assets Assets Fixed Fixed assets assets are are long long term term or or relatively relatively permanent permanent assets assets Fixed Fixed assets assets are are tangible tangible assets assets because because they they exist exist physically. physically. They They are are owned owned and and used used by by the the business business and and are are not not held held for for sale sale as as part part of of normal normal operations. operations.

Classifying Classifying Costs Costs Is the purchased item long-lived? Yes

No

Is the asset used in a productive purpose? Yes No

Fixed Assets

Expense

Investment

Land Land •• •• •• •• •• ••

Purchase Purchase price price Sales Sales taxes taxes Permits Permits from from government government agencies agencies Broker’s Broker’s commissions commissions Title Title fees fees Surveying Surveying fees fees

Land Land •• •• •• •• •• ••

Purchase Purchase price price •• Delinquent real estate taxes Delinquent real estate taxes Sales taxes Sales taxes •• from Razing or Razing or removing removing Permits government Permits from government unwanted buildings, buildings, less less the the agencies agenciesunwanted salvage salvage Broker’s Broker’s commissions commissions •• Grading and leveling Grading and leveling Title fees Title fees •• Paving aa public street Paving public street Surveying fees Surveying fees bordering bordering the the land land

Buildings Buildings  Architects’ fees  Engineers’ fees  Insurance costs incurred

during construction  Interest on money borrowed to finance construction  Walkways to and around the building

Buildings Buildings  Sales taxes  Repairs (purchase of

existing building)  Reconditioning (purchase of an existing building)  Modifying for use  Permits from governmental agencies

Land Improvements • • • • • •

Trees and shrubs Fences Parking areas Outdoor lighting Concrete sewers and drainage Paved parking areas

Machinery Machinery and and Equipment Equipment Sales taxes Freight Installation Repairs (purchase of used equipment) • Reconditioning (purchase of used equipment) • • • •

Machinery Machinery and and Equipment Equipment • • • • •

Insurance while in transit Assembly Modifying for use Testing for use Permits from governmental agencies

Cost Cost of of Acquiring Acquiring Fixed Fixed Assets Assets Excludes: Excludes:     

Vandalism Mistakes in installation Uninsured theft Damage during unpacking and installing Fines for not obtaining proper permits from government agencies

Nature Nature of of Depreciation Depreciation All All fixed fixed assets assets except except land land lose lose their their capacity capacity to to provide provide services. services. This This loss loss of of productive productive capacity capacity isis recognized recognized as as Depreciation Depreciation Expense. Expense. Physical Physical depreciation depreciation occurs occurs from from wear wear and and tear tear while while in in use use and and from from the the action action of of the the weather. weather. Functional Functional depreciation depreciation occurs occurs when when aa fixed fixed asset asset isis longer longer able able to to provide provide services services at at the the level level for for which which itit was was intended, intended, e.g., e.g., personal personal computer. computer.

Depreciation Depreciation Expense Expense Factors Factors Initial Cost

-

Residual Value

=

Depreciable Cost Useful Life

1

2

3

4

5

Periodic Depreciation Expense

Use Use of of Depreciation Depreciation Methods Methods 4%

DecliningBalance

8%

Other Units-of-Production 5%

83%

Straight-Line Source: Accounting Trends & Techniques, 56th . ed., American Institute of Certified Public Accountants, New York, 2002.

Facts Facts Original Original Cost.....………….. Cost.....………….. $24,000 $24,000 Estimated 55 years Estimated Life Life in in years….. years….. years Estimated 10,000 Estimated Life Life in in hours….. hours….. 10,000 Estimated Estimated Residual Residual Value... Value...

$2,000 $2,000

Straight-Line Straight-Line Method Method Cost – estimated residual value Estimated life = Annual depreciation

Straight-Line Straight-Line Method Method $24,000 – $2,000 5 years = $4,400 annual depreciation

Straight-Line Straight-Line Rate Rate $24,000 – $2,000 = $4,400 5 years

$4,400 = 18.3% $24,000

Straight-Line Straight-Line Method Method The The straight-line straight-line method method isis widely widely used used by by firms firms because because itit isis simple simple and and itit provides provides aa reasonable reasonable transfer transfer of of cost cost to to periodic periodic expenses expenses ifif the the asset asset isis used used about about the the same same from from period period to to period. period.

Straight-Line Straight-Line Method Method Year

Cost

1 2 3 4 5

$24,000 24,000 24,000 24,000 24,000

Accum. Depr. at Beginning of Year

$ 4,400 8,800 13,200 17,600

Book Value at Beginning of Year $24,000 19,600 15,200 10,800 6,400

Depr. Expense for Year

Book Value at End of Year

$4,400 4,400 4,400 4,400 4,400

$19,600 15,200 10,800 6,400 2,000

Cost ($24,000) – Residual Value ($2,000) Estimated Useful Life (5 years)

Annual = Depreciation Expense ($4,400)

Units-of-Production Units-of-Production Method Method Cost – estimated residual value Estimated life in units, hours, etc. = Depreciation per unit, hour, etc.

Units-of-Production Units-of-Production Method Method $24,000 – $2,000 10,000 hours = Depreciation perper unit, hour, etc. = $2.20 hour

Units-of-Production Units-of-Production Method Method The The units-of-production units-of-production method method isis more more appropriate appropriate than than the the straight-line straight-line method method when when the the amount amount of of use use of of aa fixed fixed asset asset varies varies from from year year to to year. year.

Declining-Balance Declining-Balance Method Method Step Step 11 Ignoring residual value, determine the straight-line rate $24,000 – $2,000 5 years $4,800 $24,000

= $4,800 = 20%

Declining-Balance Declining-Balance Method Method There’s There’s aa shortcut. shortcut. Simply Simply divide divide one one by by the the number number of of years years (1 (1 ÷÷ 55 == .20). .20).

Declining-Balance Declining-Balance Method Method Step Step 22 Double the straight-line rate.

.20 x 2 = .40 For For the the first first year, year, the the cost cost of of the the asset asset isis multiplied multiplied by by 40 40 percent. percent. After After the the first first year, year, the the declining declining book book value value of of the the asset asset isis multiplied multiplied 40 40 percent. percent.

Declining-Balance Declining-Balance Method Method Step Step 33

Build a table.

Declining-Balance Declining-Balance Method Method Year 1

Book Value Beginning of Year Rate $24,000

40%

Annual Deprec.

Accum. Deprec. Year-End

$9,600

$24,000 $24,000 xx .40 .40

Book Value Year-End

Declining-Balance Declining-Balance Method Method Year 1

Book Value Beginning of Year Rate $24,000

40%

Annual Deprec.

Accum. Deprec. Year-End

$9,600

$9,600

Book Value Year-End $14,400

Declining-Balance Declining-Balance Method Method Year 1 2

Book Value Beginning of Year Rate $24,000 14,400

Annual Deprec.

40% 40%

Accum. Deprec. Year-End

$9,600 5,760

$14,400 $14,400 xx .40 .40

$9,600

Book Value Year-End $14,400

Declining-Balance Declining-Balance Method Method Year 1 2

Book Value Beginning of Year Rate $24,000 14,400

40% 40%

Annual Deprec.

Accum. Deprec. Year-End

$9,600 5,760

$9,600 15,360

Book Value Year-End $14,400 8,640

Declining-Balance Declining-Balance Method Method Year 1 2 3

Book Value Beginning of Year Rate $24,000 14,400 8,640

40% 40% 40%

Annual Deprec.

Accum. Deprec. Year-End

$9,600 5,760 3,456

$9,600 15,360 18,816

Book Value Year-End $14,400 8,640 5,184

Declining-Balance Declining-Balance Method Method Year 1 2 3 4

Book Value Beginning of Year Rate $24,000 14,400 8,640 5,184

40% 40% 40% 40%

Annual Deprec.

Accum. Deprec. Year-End

$9,600 5,760 3,456 2,074

$9,600 15,360 18,816 20,890

Book Value Year-End $14,400 8,640 5,184 3,110

Declining-Balance Declining-Balance Method Method Year

Book Value Beginning of Year Rate

Annual Deprec.

Accum. Deprec. Year-End

1 2 3 4 5

$24,000 STOP! STOP! 40% 14,400 40% 8,640 40% 5,184 40% 3,110 40%

$9,600 5,760 3,456 2,074 1,244

$9,600 15,360 18,816 20,890 22,134

Book Value Year-End $14,400 8,640 5,184 3,110 1,866

Declining-Balance Declining-Balance Method Method

Year 1 2 3 4 5

IfIf we use 5, we use this this approach approach in in Year Year 5, we we will will Book Value Accum. end aa book of Beginning Deprec. Book Value end the the year year with withAnnual book value value of $1,866. $1,866. of Year Rate Deprec. value Year-End Year-End Remember, the at Remember, the residual residual value at the the end end of of Year expected to $24,000 $9,600 $9,600so Year 55 isis40% expected to be be $2,000, $2,000, so we we$14,400 modify our 14,400 must 40% 5,760 15,360 8,640 must modify our approach. approach. 8,640 40% 3,456 18,816 5,184 5,184 40% 2,074 20,890 3,110 3,110 40% 1,244 22,134 1,866

Declining-Balance Declining-Balance Method Method Year 1 2 3 4 5

Book Value Beginning of Year Rate $24,000 14,400 8,640 5,184 3,110

40% 40% 40% 40% ---

Annual Deprec. $9,600 5,760 3,456 2,074 1,110

Accum. Deprec. Year-End $9,600 15,360 18,816 20,890

$3,110 $3,110 –– $2,000 $2,000

Book Value Year-End $14,400 8,640 5,184 3,110

Declining-Balance Declining-Balance Method Method Year 1 2 3 4 5

Book Value Beginning of Year Rate $24,000 14,400 8,640 5,184 3,110

40% 40% 40% 40% ---

Annual Deprec.

Accum. Deprec. Year-End

$9,600 5,760 3,456 2,074 1,110

$9,600 15,360 18,816 20,890 22,000

Book Value Year-End $14,400 8,640 5,184 3,110 2,000 Desired ending book value

Comparing Comparing Straight-Line Straight-Line With With the the Declining-Balance Declining-Balance Method Method

Depreciation ($)

Straight-Line Method

Declining-Balance Method

5,000 4,000 3,000 2,000 1,000 0

1 2 3 Life (years)

4

1 2 3 Life (years)

4

Revising Revising Depreciation Depreciation Estimates Estimates A A machine machine purchased purchased for for $130,000 $130,000 was was originally originally estimated estimated to to have have aa useful useful life life of of 30 30 years years and and aa residual residual value value of of $10,000. $10,000. The The asset asset has has been been depreciated depreciated for for ten ten years years using using the the straightstraightline line method. method.

Annual Depreciation $130,000 – $10,000 30 years

$4,000 per year

Revising Revising Depreciation Depreciation Estimates Estimates Equipment 130,000

Book value = $90,000

Before Before revising revising

Accumulated Depreciation 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 40,000

Revising Revising Depreciation Depreciation Estimates Estimates During the eleventh year, it is estimated that the remaining useful life is 25 years (rather than 20) and that the revised estimated residual value is $5,000. Book value – revised residual value Revised estimated remaining life $3,400 revised $90,000 – $5,000 = annual depreciation 25 years

Capital Capital and and Revenue Revenue Expenditures Expenditures Expenditures Expenditures made made to to acquire acquire new new plant plant assets assets are are known known as as capital capital expenditures. expenditures.

Capital Capital and and Revenue Revenue Expenditures Expenditures Expenditures Expenditures to to repair repair or or maintain maintain plant plant assets assets that that do do not not extend extend the the life life or or enhance enhance the the value value are are known known as as revenue revenue expenditures. expenditures.

Capital Capital and and Revenue Revenue Expenditures Expenditures EXPENDITURE

Increases Increases operating useful life No efficiency or adds (extraordinary to capacity? repairs)? Yes Capital Expenditure (Debit fixed asset account)

Revenue Expenditure (Debit expense No account for ordinary maintenance and repairs)

Yes Capital Expenditure (Debit accumulated depreciation account)

Capital Capital and and Revenue Revenue Expenditures Expenditures LIABILITIES

CAPITAL EXPENDITURES 1.1.Initial Initialcost cost 2.2.Additions Additions 3.3.Betterments Betterments 4.4.Extraordinary Extraordinary repairs repairs

ASSETS

OWNER’S EQUITY net income

EXPENSES

REVENUES

Capital Capital and and Revenue Revenue Expenditures Expenditures LIABILITIES ASSETS

OWNER’S EQUITY net income

REVENUE EXPENDITURES Normal and ordinary repairs and maintenance

EXPENSES

REVENUES

Accounting Accounting for for Fixed Fixed Asset Asset Disposals Disposals When fixed assets lose their usefulness they may be disposed of in one of the following ways: 1. discarded, 2. sold, or 3. traded (exchanged) for similar assets. Required entries will vary with type of disposition and circumstances, but the following entries will always be necessary: An asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove it’s balance from the ledger.

Discarding Discarding Fixed Fixed Assets Assets A A piece piece of of equipment equipment acquired acquired at at aa cost cost of of $25,000 $25,000 isis fully fully depreciation. depreciation. On On February February 14, 14, the the equipment equipment isis discarded. discarded.

Discarding Discarding Fixed Fixed Assets Assets Feb. 14 Accumulated Depr.—Equipment Equipment To write off fully depreciated equipment.

25 000 00 25 000 00

Discarding Discarding Fixed Fixed Assets Assets Equipment Equipment costing costing $6,000 $6,000 isis depreciation depreciation at at an an annual annual straight-line straight-line rate rate of of 10%. 10%. After After the the adjusting adjusting entry, entry, Accumulated Accumulated Depreciation— Depreciation— Equipment Equipment had had aa $4,750 $4,750 balance. balance. The The equipment equipment was was discarded discarded on on March March 24. 24. Mar. 24 Depreciation Expense.—Equipment

150 00

Accum. Depreciation—Equipment To record current depreciation on equipment discarded.

150 00

$600 $600xx3/12 3/12

Discarding Discarding Fixed Fixed Assets Assets Equipment Equipment costing costing $6,000 $6,000 isis depreciation depreciation at at an an annual annual straight-line straight-line rate rate of of 10%. 10%. After After the the adjusting adjusting entry, entry, Accumulated Accumulated Depreciation— Depreciation— Equipment Equipment had had aa $4,750 $4,750 balance. balance. The The equipment equipment was was discarded discarded on on March March 24. 24. Mar. 24 Accumulated Depr.—Equipment

4 900 00

Loss on Disposal of Fixed Asset

1 100 00

Equipment To write off equipment discarded.

6 000 00

Sale Sale of of Fixed Fixed Assets Assets When fixed assets are sold, the owner may break even, sustain a loss, or realize a gain. 1. If the sale price is equal to book value, there will be no gain or loss. 2. If the sale price is less than book value, there will be a loss equal to the difference. 3. If the sale price is more than book value, there will be a gain equal to the difference.

Gain or loss will be reported in the income statement as Other Income or Other Loss.

Sale Sale of of Fixed Fixed Assets Assets Equipment Equipment costing costing $10,000 $10,000 isis depreciated depreciated at at an an annual annual straight-line straight-line rate rate of of 10%. 10%. The The equipment equipment isis sold sold for for cash cash on on October October 12. 12. Accumulated Accumulated Depreciation Depreciation (last (last adjusted adjusted December December 31) 31) has has aa balance balance of of $7,000. $7,000. Oct. 12 Depreciation Expense—Equipment

750 00

Accumulated Depr.—Equipment To record current depreciation on equipment sold.

750 00

$10,000 $10,000 xx ¾ ¾ x10% x10%

Sale Sale of of Fixed Fixed Assets Assets Assumption Assumption 1: 1: The The equipment equipment isis sold sold for for $2,250, $2,250, so so there there isis no no gain gain or or loss. loss. Oct. 12 Cash

2 250 00

Accumulated Depr.—Equipment Equipment Sold equipment.

7 750 00 10 000 00

Sale Sale of of Fixed Fixed Assets Assets Assumption Assumption 2: 2: The The equipment equipment isis sold sold for for $1,000, $1,000, so so there there isis aa loss loss of of $1,250. $1,250. Oct. 12 Cash

1 000 00

Accumulated Depr.—Equipment

7 750 00

Loss on Disposal of Fixed Assets

1 250 00

Equipment Sold equipment.

10 000 00

Sale Sale of of Fixed Fixed Assets Assets Assumption Assumption 2: 2: The The equipment equipment isis sold sold for for $2,800, $2,800, so so there there isis aa gain gain of of $550. $550. Oct. 12 Cash

2 800 00

Accumulated Depr.—Equipment Equipment Gain on Disposal of Fixed Assets Sold equipment.

7 750 00 10 000 00 550 00

Exchanges Exchanges of of Similar Similar Fixed Fixed Assets Assets  Trade-in Allowance (TIA) – amount allowed for old equipment toward the purchase price of similar new assets.  Boot – balance owed on new equipment after trade-in allowance has been deducted.  TIA > Book Value = Gain on Trade  TIA < Book Value = Loss on Trade  Gains are never recognized (not recorded).  Losses must be recognized (recorded).

Exchanges Exchanges of of Similar Similar Fixed Fixed Assets Assets List price of new equipment acquired Cost of old equipment traded in Accum. depreciation at date of exchange Book value at date of exchange

$5,000 $4,000 3,200 $ 800

CASE ONE (GAIN): Trade-in allowance, $1,100 Cash paid, $3,900 ($5,000 – $1,100) Gains Gains are are not not TIA > Book Value = Gain recognized recognized for for $1,100 – $800 = $300 financial financial reporting. reporting. Boot + Book = Cost of New Equipment $3,900 + $800 = $4,700

Exchanges Exchanges of of Similar Similar Fixed Fixed Assets Assets On June 19, equipment exchanged at a gain of $300. June 19 Accumulated Depr.—Equipment Equipment (new equipment)

3 200 00 4 700 00

Equipment (old equipment)

4 000 00

Cash

3 900 00

Exchanges Exchanges of of Similar Similar Fixed Fixed Assets Assets List price of new equipment acquired $10,000 Cost of old equipment traded in $7,000 Accum. depreciation at date of exchange 4,600 Book value at date of exchange $2,400 CASE TWO (LOSS): Trade-in allowance, $2,000 Cash paid, $8,000 ($10,000 – $2,000) TIA
financial financial reporting. reporting.

Exchanges Exchanges of of Similar Similar Fixed Fixed Assets Assets On September 7, equipment exchanged at a loss of $400. Sept. 7 Accumulated Depr.—Equipment Equipment (new equipment) Loss on Disposal of Fixed Assets

4 600 00 10 000 00 400 00

Equipment (old equipment)

7 000 00

Cash

8 000 00

Natural Natural Resources Resources and and Depletion Depletion Depletion Depletion isis the the process process of of transferring transferring the the cost cost of of natural natural resources resources to to an an expense expense account. account.

Natural Natural Resources Resources and and Depletion Depletion A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore. The depletion rate is $0.40 per ton ($400,000 ÷ 1,000,000 tons).

Natural Natural Resources Resources and and Depletion Depletion During the current year, 90,000 tons are mined. The periodic depletion is $36,000 (90,000 tons x $0.40). Adjusting Entry Dec. 31 Depletion Expense Accumulated Depletion

36 000 00 36 000 00

Intangible Assets and Amortization Amortization is the periodic cost expiration of intangible assets which do not have physical attributes and are not held for sale (patents, copyrights, and goodwill). Date

Description

Dec. 31 Amortization Expense Patents

20,000

Debit Credit

20,000

Paid $100,000 for patent rights. The patent life is 11 years and was issued 6 years prior to purchase. 11 years – 6 years = 5-year life ($100,000 / 5 years) = $20,000 per year

Discovery Mining Co. Partial Balance Sheet December 31, 2006 Property, plant, and equipment: Land Buildings Factory equipment Office equipment

Mineral deposits: Alaska deposit Wyoming deposit

Cost $ 30,000 110,000 650,000 120,000 $910,000 Cost

$1,200,000 750,000 $1,950,000 Total property, plant, and equipment Intangible assets: Patents Goodwill Total intangible assets

Accum. Depr. $ 26,000 192,000 13,000 $231,000

Book Value $ 30,000 84,000 458,000 107,000 $ 679,000

Accum. Depr.

Book Value

$ 800,000 200,000 $1,000,000

$400,000 550,000 950,000 $1,629,000 $

75,000 50,000 $ 125,000

Ratio of Fixed Assets to Long-Term Liabilities (in millions)

Procter & Gamble Fixed assets (net) Long-term debt

Ratio of fixed assets to long-term liabilities

2002

2001

$13,349 $11,201

$13,095 $9,792

1.2

1.3

Use: Use: To To indicate indicate the the margin margin of of safety safety to to long-term long-termcreditors creditors

Chapter 10 The The End End