Accounting: Fixed & Intangible Assets

Fixed Assets and

Intangible Assets

By Mr. Breitsprecher

Fixed Assets

• Long-term or relatively permanent assets such

as equipment, machinery, buildings, and land

• Other descriptive titles for plant assets or

property, plant, and equipment

• Fixed assets have the following characteristics:

• Exist physically and, thus, are tangible assets

• Owned & used by in normal operations

• Not offered by sale as part of operations

©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 2

Classifying Costs

• Incurred cost may be classified as a fixed asset, an

investment, or an expense

• Fixed assets include land, buildings, or equipment

• These assets normally last more than a year and are

used in the normal operations

• Investments are long-lived assets, not used in the

normal operations and are held for future resale

• Such assets are reported on the balance sheet in a

section entitled Investments


Cost of Fixed Assets

• Only costs necessary for preparing fixed assets for use are included as cost of the asset

• Unnecessary costs that do not increase the asset’s usefulness are recorded as an expense

• These include the following:• Vandalism• Mistakes in installation• Uninsured theft• Damage during unpacking and installing• Fines for not obtaining proper permits from

governmental agencies


Capital and Revenue

Expenditures

• Costs that benefit only current period, such as

ordinary maintenance and repairs, are called revenue

expenditures

• Recorded as increases to Repairs and Maintenance

Expense

• Costs that improve the asset or extend its useful life,

such as improvements or extraordinary repairs, are

called capital expenditures

• Recorded as increases to the fixed asset account


Extraordinary Repairs• Costs related to extraordinary repairs are capital

expenditures

• Recorded as a decrease in an accumulated depreciation

account

• For example, the engine of a forklift that is near the end

of its useful life may be overhauled at a cost of $4,500,

extending its useful life by eight years. This is recorded as:

• Forklift’s remaining useful life has changed, Depreciation

for the forklift will change based on the new book value

of the forklift


Leasing Fixed Assets• Lease is a contract for the use of an asset for a period of

time

• The parties to a lease contract are as follows:

• Lessor owns the asset

• Lessee receives rights to use asset as granted by the

lessor

• Leasing an asset has the following advantages:

• Lessee has access to an asset without having to finance

purchase of asset

• Expenses such as repair and maintenance may be the

responsibility of the lessor

• Risk of additional cost as asset becomes obsolete

before the end of its useful life is minimized


Depreciation

• Over time, fixed assets, with exception of

land, lose ability to provide services

• Costs of fixed assets such as equipment &

buildings should be recorded as expense over

useful life

• This periodic recording of fixed asset costs is

an expense is called depreciation

• Land has an unlimited life -- it is not

depreciated


Accounting for Depreciation

• Adjusting entry to record depreciation debits

Depreciation Expense and credits a contra asset

account entitled Accumulated Depreciation or

Allowance for Depreciation

• The use of a contra asset account allows original cost

to remain unchanged in original fixed asset account

• Depreciation can be caused by physical or functional

factors

• Physical depreciation factors include wear and tear

• Functional depreciation factors includes obsolescence


Computing

Depreciation Expense (1 of 2)• Three factors determine depreciation expense for fixed

assets:

• Asset’s initial cost

• Asset’s expected useful life

• Estimated at time asset is placed into service;

available from industry trade associations

• Asset’s estimated residual value

• Residual value of fixed asset at the end of its

useful life is also estimated at the time the asset is

placed into service

• Residual value also called scrap value, salvage value,

or trade-in value


Computing

Depreciation Expense (2 of 2)

• Difference between fixed asset’s initial cost and its

residual value is called asset’s depreciable cost.

• Depreciable cost is the amount of the

asset’s cost that is allocated over useful life

as depreciation expense.

• If fixed asset has no residual value, then its entire

cost should be allocated to depreciation


Straight-Line Method• Straight-line method provides same amount of

depreciation expense for each year of asset’s useful life:

Annual Depreciation = (Cost – Residual Value) / Useful Life

• If asset is used for only part of year, annual

depreciation is prorated

• Computation of straight-line depreciation may be

simplified by converting annual depreciation to a

percentage of depreciable cost

• Straight-line percentage is determined by dividing 100%

by the number of years of expected useful life


Units-of-Output Method• Units-of-output method provides same amount of

depreciation expense for each unit of output of asset

• Depending on asset, units of output can be expressed in

terms of hours, miles driven, or quantity produced

• Units-of-output method is applied in two steps:

• Step 1. Determine the depreciation per unit as follows:

• Step 2. Compute the depreciation expense as follows:


Double-Declining-

Balance Method (1 of 2)

• Double-declining-balance method provides for a

declining periodic expense over expected useful life of asset

• Double-declining-balance method has three steps:

• Step 1. Determine straight-line percentage, using

expected useful life

• Step 2. Determine double-declining-balance rate by

multiplying straight-line rate from Step 1 by 2

• Step 3. Compute depreciation expense by multiplying

double-declining-balance rate from Step 2 times the

book value of asset. For first year, book value of asset

is its initial cost


Double-Declining-

Balance Method (2 of 2)

• Double-declining-balance method provides higher

depreciation in first year of asset’s use, followed by

declining depreciation amounts

• It is called an accelerated depreciation method

• Asset’s revenues are often greater in early years of

use than in later years

• In such cases, double-declining-balance method

provides a good matching of depreciation expense

with asset’s revenues


Depreciation for Federal

Income Tax• Internal Revenue Code uses Modified Accelerated Cost

Recovery System (MACRS) to compute depreciation for tax

purposes

• MACRS has eight classes of useful life and depreciation

rates for each class

• Two of the most common classes are:

• The five-year class includes automobiles and light-duty

trucks

• The seven-year class includes most machinery and

equipment


Revising

Depreciation Estimates

• Estimates of residual values and useful lives of

fixed assets may change

• Abnormal wear and tear or obsolescence

• When new estimates are determined, they are

used to determine depreciation expense in future

periods

• Depreciation expense recorded in earlier years is

not affected


Discarding Fixed Assets

• If fixed asset is no longer used and has no residual value, it is discarded

• Entry to record disposal of a fixed asset removes cost of the asset and its accumulated depreciation from accounts

• A loss is recorded if balance of accumulated depreciation account is less than balance in fixed asset account

• These losses are reported on income statement.• If asset has not been fully depreciated, depreciation

should be recorded before removing asset from accounting records


Selling Fixed Assets

• Entry to record sale of fixed asset is similar to

entry for discarding an asset

• D difference is that receipt of cash is also

recorded

• If selling price is more than book value of asset, a

gain is recorded

• If selling price is less than book value, a loss is

recorded


Natural Resources (1 of 2)

• Fixed assets of some companies include timber,

metal ores, minerals, or other natural resources

• As resources are harvested or mined and then

sold, a portion of their cost is debited to an

expense account

• This process of transferring the cost of natural

resources to an expense account is called

depletion


Natural Resources (2 of 2)

• Depletion is determined as follows:

• Step 1. Determine depletion rate as follows:

• Step 2. Multiply depletion rate by quantity extracted

from resource during period

• Adjusting entry to record depletion debits depletion

expense & credits accumulated depletion


Intangible Assets• Patents, copyrights, trademarks, and goodwill are long-

lived assets used in the operations of a business and

are not held for sale

• Called intangible assets as they do not exist physically

• Accounting for intangible assets is similar to that for

fixed assets. Major issues are:

• Determining initial cost

• Determining amortization, which is amount of

cost to transfer to expense

• Amortization results from passage of time or a

decline in usefulness of intangible asset


Patents (1 of 2)

• Manufacturers may acquire exclusive rights to produce

and sell goods with unique features

• Such rights are granted by patents, which federal

government issues to inventors

• These rights continue in effect for 20 years

• Business may purchase patent rights from others

• However, if a company develops its own patent

through research and development, costs are usually

recorded as current operating expenses in period in

which they are incurred


Patents (2 of 2)

• Initial cost of purchased patent, including any legal

fees, is debited to an asset account

• This cost is written off, or amortized over years of the

patent’s expected useful life

• Patent amortization is normally computed using

straight-line method

• Amortization is recorded by debiting an amortization

expense account and crediting the patents account

• A separate contra asset account is usually not used for

intangible assets


Copyrights and Trademarks (1 of 2)

• Exclusive right to publish and sell a literary, artistic, or

musical composition is granted by copyright

• Copyrights are issued by federal government and extend

for 70 years beyond author’s death

• Costs of a copyright include all costs of creating the

work plus any other costs of obtaining copyright. A

copyright that is purchased is recorded at the price paid

for it

• Copyrights are amortized over their estimated useful

lives


Copyrights and Trademarks (2 of 2)

• Trademark is a name, term, or symbol used to identify a

business and its products

• Most businesses identify their trademarks with ® in

advertisements and on products

• Trademarks can be registered for 10 years and renewed for

10-year periods thereafter

• Legal costs of registering a trademark are recorded as asset

• If trademark is purchased from another business, its cost is

recorded as an asset and reviewed periodically for impaired

value, at which point a loss would be recorded


Goodwill

• Goodwill refers to an intangible asset of a business that

is created from such favorable factors as location,

product quality, reputation, and managerial skill

• Generally accepted accounting principles (GAAP) allow

goodwill to be recorded only if objectively determined

by a transaction

• An example is purchase of a business at a price in

excess of fair value of its net assets (assets – liabilities)

• Excess is recorded as goodwill and reported as an

intangible asset


Financial Reporting for Fixed

Assets and Intangible Assets (1 of 2)

• In the income statement, depreciation and amortization expense should be reported separately or disclosed in a note

• A description of the methods used in computing depreciation should also be reported

• In the balance sheet, each class of fixed assets should be disclosed on the face of the statement or in the notes

• The related accumulated depreciation should also be disclosed, either by class or in total


Financial Reporting for Fixed

Assets and Intangible Assets (2 of 2)

• Fixed assets may be shown at their book value (cost less

accumulated depreciation)

• If there are many classes of fixed assets, a single amount

may be presented in the balance sheet, supported by a note

with separate listing

• Fixed assets may be reported under more descriptive

caption of property, plant, and equipment

• Intangible assets are usually reported in balance in a separate

section following fixed assets

• Balance of each class of intangible assets should be

disclosed net of any amortization


Analysis and Interpretation:

Fixed Asset Turnover Ratio• A measure of a company’s efficiency in using its fixed

assets to generate revenue is fixed asset turnover ratio

• Fixed asset turnover ratio measures number of dollars

of sales earned per dollar of fixed assets

• Computed as follows:

• Higher fixed asset turnover, the more efficiently a

company is using its fixed assets in generating sales

Fixed Asset Turnover Ratio =

Sales

Average Book Value of Fixed Assets


Exchanging Similar

Fixed Assets (1 of 2)

• Old equipment is often traded for new equipment

having a similar use

• Seller allows buyer an amount for old equipment

traded in

• This amount, called the trade-in allowance, may be

greater than or less than book value of the old

equipment

• Remaining balance—the amount owed—is either

paid in cash or recorded as a liability

• It is normally called boot, which is its tax name


Exchanging Similar

Fixed Assets (2 of 2)

• Accounting for exchange of similar assets depends

on whether transaction has commercial substance

• An exchange has commercial substance if future

cash flows change as a result of exchange

• If an exchange of similar assets has commercial

substance, a gain or loss is recognized

• In such cases, the exchange is accounted for similar

to that of a sale of a fixed asset


Accounting: Fixed & Intangible Assets

Business

Transcript of Accounting: Fixed & Intangible Assets