1 Chapter 9 Fixed Assets and Intangible Assets Financial and Managerial Accounting 8th Edition...

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Chapter Chapter 99Fixed Assets and Fixed Assets and Intangible AssetsIntangible Assets

Financial and Managerial Accounting

8th Edition

Warren Reeve Fess

© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.

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1. Define fixed assets and describe the accounting for their cost.

2. Compute depreciation, using the following methods: straight-line method, units-of-production method, and declining-balance method.

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.

ObjectivesObjectivesObjectivesObjectives

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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.

ObjectivesObjectivesObjectivesObjectives

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Nature of Fixed AssetsNature of Fixed AssetsNature of Fixed AssetsNature of Fixed Assets

Fixed assets are long term or relatively permanent assets

Fixed assets are long term or relatively permanent assets

Fixed assets are tangible assets because they exist physically.

Fixed assets are tangible assets because they exist physically.

They are owned and used by the business and are not held for sale

as part of normal operations.

They are owned and used by the business and are not held for sale

as part of normal operations.

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Classifying CostsClassifying CostsClassifying CostsClassifying Costs

Is the purchased item long-lived?

Yes

Is the asset used in a productive

purpose?

No

Expense

Yes

Fixed Assets

No

Investment

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LandLandLandLand

Purchase pricePurchase price Sales taxesSales taxes Permits from government Permits from government

agenciesagencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees

Purchase pricePurchase price Sales taxesSales taxes Permits from government Permits from government

agenciesagencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees

Delinquent real estate taxesDelinquent real estate taxes Razing or removing Razing or removing

unwanted buildings, less the unwanted buildings, less the salvagesalvage

Grading and levelingGrading and leveling Paving a public street Paving a public street

bordering the landbordering the land

Delinquent real estate taxesDelinquent real estate taxes Razing or removing Razing or removing

unwanted buildings, less the unwanted buildings, less the salvagesalvage

Grading and levelingGrading and leveling Paving a public street Paving a public street

bordering the landbordering the land

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Architects’ fees Engineers’ fees Insurance costs incurred

during construction Interest on money

borrowed to finance construction

Walkways to and around the building

BuildingsBuildingsBuildingsBuildings

Sales taxes Repairs (purchase of

existing building) Reconditioning

(purchase of an existing building)

Modifying for use Permits from

governmental agencies

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

Land ImprovementsLand Improvements

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Machinery and EquipmentMachinery and Equipment

Sales taxes Freight Installation Repairs (purchase of used

equipment) Reconditioning (purchase

of used equipment)

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

governmental agencies

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Cost of Acquiring Fixed Assets Excludes:Cost of Acquiring Fixed Assets Excludes:Cost of Acquiring Fixed Assets Excludes:Cost of Acquiring Fixed Assets Excludes: Vandalism Mistakes in installation Uninsured theft Damage during unpacking and installing Fines for not obtaining proper permits from

government agencies

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Nature of DepreciationNature of DepreciationNature of DepreciationNature of Depreciation

All fixed assets except land lose their capacityto provide services. This loss of productive

capacity is recognized as Depreciation Expense.

All fixed assets except land lose their capacityto provide services. This loss of productive

capacity is recognized as Depreciation Expense.

Physical depreciation occurs from wear and tear while in use and from the action of the weather.

Physical depreciation occurs from wear and tear while in use and from the action of the weather.

Functional depreciation occurs when a fixed asset is longer able to provide services at the level for

which it was intended, e.g., personal computer.

Functional depreciation occurs when a fixed asset is longer able to provide services at the level for

which it was intended, e.g., personal computer.

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Depreciation Expense FactorsDepreciation Expense FactorsDepreciation Expense FactorsDepreciation Expense Factors

Initial Cost Residual Value- = Depreciable Cost

Useful Life

1

Periodic Depreciation Expense

2 3 4 5

14

83%

4%8% 5%

Straight-Line

Declining- Balance

Other Units-of-Production

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

Use of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation Methods

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FactsFactsFactsFacts

Original Cost.....………….. $24,000

Estimated Life in years….. 5 years

Estimated Life in hours….. 10,000

Estimated Residual Value... $2,000

Original Cost.....………….. $24,000

Estimated Life in years….. 5 years

Estimated Life in hours….. 10,000

Estimated Residual Value... $2,000

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Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Cost – estimated residual value

Estimated life

= Annual depreciation

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$24,000 – $2,000

5 years

= $4,400 annual depreciation

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Straight-Line RateStraight-Line RateStraight-Line RateStraight-Line Rate

$24,000 – $2,000

5 years = $4,400

$4,400 $24,000

= 18.3%

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The straight-line method is widely used by firms because it is simple and it

provides a reasonable transfer of cost to periodic expenses if the asset is used

about the same from period to period.

The straight-line method is widely used by firms because it is simple and it

provides a reasonable transfer of cost to periodic expenses if the asset is used

about the same from period to period.

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Accum. Depr. Book Value Depr. Book Valueat Beginning at Beginning Expense at End

Year Cost of Year of Year for Year of Year

1 $24,000 $24,000 $4,400 $19,600

2 24,000 $ 4,400 19,600 4,400 15,200

3 24,000 8,800 15,200 4,400 10,800

4 24,000 13,200 10,800 4,400 6,400

5 24,000 17,600 6,400 4,400 2,000

Cost ($24,000) Cost ($24,000) –– Residual Value ($2,000) Residual Value ($2,000)

Estimated Useful Life (5 years)Estimated Useful Life (5 years)=

Annual Annual DepreciationDepreciation

Expense ($4,400)Expense ($4,400)


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Units-of-Production MethodUnits-of-Production MethodUnits-of-Production MethodUnits-of-Production Method

Cost – estimated residual valueEstimated life in units, hours, etc.

= Depreciation per unit, hour, etc.

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$24,000 – $2,000

10,000 hours

= Depreciation per unit, hour, etc.= $2.20 per hour


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The units-of-production method is more appropriate than the

straight-line method when the amount of use of a fixed asset

varies from year to year.

The units-of-production method is more appropriate than the

straight-line method when the amount of use of a fixed asset

varies from year to year.


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Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

Step 1Step 1

Ignoring residual value, determine the straight-line rate

= $4,800 $24,000 – $2,000

5 years

$4,800

$24,000= 20%

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There’s a shortcut. Simply divide one by the number of

years (1 ÷ 5 = .20).

There’s a shortcut. Simply divide one by the number of

years (1 ÷ 5 = .20).


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Double the straight-line rate.

Step 2Step 2

.20 x 2 = .40

For the first year, the cost of the asset is multiplied by 40 percent. After the first year,

the declining book value of the asset is multiplied 40 percent.

For the first year, the cost of the asset is multiplied by 40 percent. After the first year,

the declining book value of the asset is multiplied 40 percent.


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Build a table.

Step 3Step 3


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Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End

1 $24,000 40% $9,600


$24,000 x .40$24,000 x .40

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1 $24,000 40% $9,600 $9,600 $14,400


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760


$14,400 x .40$14,400 x .40

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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 40% 1,244 22,134 1,866


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 40% 1,244 22,134 1,866


If we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of Year 5 is expected to

be $2,000, so we must modify our approach.

If we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of Year 5 is expected to

be $2,000, so we must modify our approach.

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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 --- 1,110


$3,110 – $2,000$3,110 – $2,000

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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 --- 1,110 22,000 2,000

Desired ending book

value


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

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

Straight-LineMethod

Dep

reci

atio

n ($

) 5,000

4,000

3,000

2,000

1,000

0

Life (years)

Declining-BalanceMethod

Life (years) 1 2 3 4 1 2 3 4

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Revising Depreciation EstimatesRevising Depreciation EstimatesRevising Depreciation EstimatesRevising Depreciation Estimates

A machine purchased for $130,000 was originally

estimated to have a useful life of 30 years and a

residual value of $10,000. The asset has been

depreciated for ten years using the straight-

line method.

A machine purchased for $130,000 was originally

estimated to have a useful life of 30 years and a

residual value of $10,000. The asset has been

depreciated for ten years using the straight-

line method.

Annual Depreciation

$130,000 – $10,000

30 years

$4,000 per year

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Equipment

130,000

Accumulated Depreciation

4,0004,0004,0004,0004,0004,0004,0004,0004,000

4,00040,000Before revisingBefore revisingBefore revisingBefore revising

Book value = $90,000


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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


$90,000 – $5,000

25 years

$3,400 revised annual depreciation=

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Expenditures made to acquire new plant assets are known as capital

expenditures.

Expenditures made to acquire new plant assets are known as capital

expenditures.

Capital and Revenue ExpendituresCapital and Revenue ExpendituresCapital and Revenue ExpendituresCapital and Revenue Expenditures

Expenditures to repair or maintain plant assets that do

not extend the life or enhance the value are known as revenue expenditures.

Expenditures to repair or maintain plant assets that do

not extend the life or enhance the value are known as revenue expenditures.

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EXPENDITURE

Increases operating

efficiency or adds to capacity?

Capital Expenditure

(Debit fixed asset account)

YesYes


Increases useful life

(extraordinary repairs)?

NoNo

Capital Expenditure (Debit accumulated

depreciation account)

YesYes

Revenue Expenditure

(Debit expense account for

ordinary maintenance and repairs)

NoNo

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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

EXPENSES

CAPITAL CAPITAL EXPENDITURESEXPENDITURES

1. Initial cost1. Initial cost2. Additions2. Additions3. Betterments3. Betterments4. Extraordinary 4. Extraordinary

repairsrepairs

1. Initial cost1. Initial cost2. Additions2. Additions3. Betterments3. Betterments4. Extraordinary 4. Extraordinary

repairsrepairs

net income


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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

EXPENSES

net income

Normal and Normal and ordinary repairs ordinary repairs and maintenanceand maintenance

REVENUE REVENUE EXPENDITURESEXPENDITURES


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Accounting for Fixed Asset DisposalsAccounting for Fixed Asset DisposalsAccounting for Fixed Asset DisposalsAccounting for Fixed Asset DisposalsWhen fixed assets lose their usefulness they may be disposed of in one of the following ways:

1. discarded,2. sold, or3. 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.

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A piece of equipment acquired at a cost of

$25,000 is fully depreciated. On February

14, the equipment is discarded.

A piece of equipment acquired at a cost of

$25,000 is fully depreciated. On February

14, the equipment is discarded.

Discarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed Assets

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Feb. 14 Accumulated Depr.—Equipment 25 000 00

To write off fully depreciated

equipment.

Equipment 25 000 00

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Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. After the

adjusting entry, Accumulated Depreciation—Equipment had a $4,750 balance. The equipment

was discarded on March 24.

Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. After the

adjusting entry, Accumulated Depreciation—Equipment had a $4,750 balance. The equipment

was discarded on March 24.

Mar. 24 Depreciation Expense.—Equipment 150 00

To record current depreciation

on equipment discarded.

Accum. Depreciation—Equipment 150 00


$600 x 3/12$600 x 3/12

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Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. After the adjusting entry,

Accumulated Depreciation—Equipment had a $4,750 balance. The equipment was discarded on

March 24.

Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. After the adjusting entry,

Accumulated Depreciation—Equipment had a $4,750 balance. The equipment was discarded on

March 24.

Mar. 24 Accumulated Depr.—Equipment 4 900 00

Loss on Disposal of Fixed Asset 1 100 00

To write off equipment

discarded.

Equipment 6 000 00


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

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.

Sale of Fixed AssetsSale of Fixed AssetsSale of Fixed AssetsSale of Fixed Assets

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Equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The

equipment is sold for cash on October 12. Accumulated Depreciation (last adjusted December 31) has a balance of $7,000.

Equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The

equipment is sold for cash on October 12. Accumulated Depreciation (last adjusted December 31) has a balance of $7,000.

Oct. 12 Depreciation Expense—Equipment 750 00

To record current depreciation

on equipment sold.

Accumulated Depr.—Equipment 750 00

$10,000 x ¾ $10,000 x ¾ x10%x10%

$10,000 x ¾ $10,000 x ¾ x10%x10%

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Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.

Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.

Oct. 12 Cash 2 250 00

Sold equipment.

Accumulated Depr.—Equipment 7 750 00

Equipment 10 000 00

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Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.

Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.

Oct. 12 Cash 1 000 00

Sold equipment.


Equipment 10 000 00

Loss on Disposal of Fixed Assets 1 250 00

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Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.

Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.

Sold equipment.

Equipment 10 000 00 Gain on Disposal of Fixed Assets 550 00


Oct. 12 Cash 2 800 00

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Exchanges of Similar Fixed AssetsExchanges of Similar Fixed AssetsExchanges of Similar Fixed AssetsExchanges of Similar Fixed 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).

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CASE ONE (GAIN):

Trade-in allowance, $1,100

Cash paid, $3,900 ($5,000 – $1,100)

TIA > Book Value = Gain

$1,100 – $800 = $300

Boot + Book = Cost of New Equipment

$3,900 + $800 = $4,700

List price of new equipment acquired $5,000

Cost of old equipment traded in $4,000Accum. depreciation at date of exchange 3,200

Book value at date of exchange $ 800

Exchanges of Similar Fixed AssetsExchanges of Similar Fixed AssetsExchanges of Similar Fixed AssetsExchanges of Similar Fixed Assets

Gains are not recognized for

financial reporting.

Gains are not recognized for


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June 19 Accumulated Depr.—Equipment 3 200 00

Equipment (new equipment) 4 700 00

Equipment (old equipment) 4 000 00Cash 3 900 00

On June 19, equipment exchanged at a gain of $300.

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CASE TWO (LOSS):

Trade-in allowance, $2,000

Cash paid, $8,000 ($10,000 – $2,000)

TIA<Book Value = Loss

$2,000 – $2,400 = $400

List price of new equipment acquired $10,000

Cost of old equipment traded in $7,000Accum. depreciation at date of exchange 4,600

Book value at date of exchange $2,400


Losses are recognized for


Losses are recognized for


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Sept. 7 Accumulated Depr.—Equipment 4 600 00

Equipment (new equipment) 10 000 00

Loss on Disposal of Fixed Assets 400 00

On September 7, equipment exchanged at a loss of $400.

Equipment (old equipment) 7 000 00

Cash8 000 00

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Natural Resources and DepletionNatural Resources and DepletionNatural Resources and DepletionNatural Resources and 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).

Depletion is the process of transferring the cost of natural resources to an expense account.

Depletion is the process of transferring the cost of natural resources to an expense account.

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Natural Resources and DepletionNatural Resources and DepletionNatural Resources and DepletionNatural Resources and Depletion

Adjusting Entry

Accumulated Depletion36 000 00

During the current year, 90,000 tons are mined. The periodic depletion is $36,000 (90,000 tons x $0.40).

Dec. 31 Depletion Expense 36 000 00

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DateDate DescriptionDescription DebitDebit CreditCredit

Intangible Assets and AmortizationIntangible Assets and Amortization

Dec. 31 Amortization Expense 20,000Patents 20,000

Paid $100,000 for patent rights. The patent life is 11 years and was issued 6 years prior to purchase.

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).

11 years – 6 years = 5-year life ($100,000 / 5 years) = $20,000 per year

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Alaska deposit $1,200,000 $ 800,000 $400,000 Wyoming deposit 750,000 200,000 550,000 $1,950,000 $1,000,000 950,000

Total property, plant, and equipment $1,629,000

Intangible assets:Patents $ 75,000Goodwill 50,000 Total intangible assets $ 125,000

Discovery Mining Co.Partial Balance SheetDecember 31, 2006

Accum. BookProperty, plant, and equipment: Cost Depr. Value

Land $ 30,000 $ 30,000Buildings 110,000 $ 26,000 84,000Factory equipment 650,000 192,000 458,000Office equipment 120,000 13,000 107,000

$910,000 $231,000 $ 679,000

Accum. Book Mineral deposits: Cost Depr. Value

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Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities

(in millions)2002 2001

Procter & Gamble

Fixed assets (net) $13,349 $13,095Long-term debt $11,201 $9,792

Ratio of fixed assets toRatio of fixed assets tolong-term liabilitieslong-term liabilities 1.2 1.2 1.3 1.3

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

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

The EndThe End

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