Ch09 wrd12e instructor_final

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Fixed Assets and

Fixed Assets and

Intangible Intangible

AssetsAssets

Chapter 9Chapter 9Chapter 9Chapter 9

Learning ObjectivesLearning Objectives

1.1. Define, classify, and account for the cost Define, classify, and account for the cost of fixed assets.of fixed assets.

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

3.3. Journalize entries for the disposal of fixed Journalize entries for the disposal of fixed assets.assets.

4.4. Compute depletion and journalize the Compute depletion and journalize the entry for depletion.entry for depletion.

Learning ObjectivesLearning Objectives

5.5. Describe the accounting for intangible Describe the accounting for intangible assets, such as patents, copyrights, and assets, such as patents, copyrights, and goodwill.goodwill.

6.6. Describe how depreciation expense is Describe how depreciation expense is reported in an income statement and reported in an income statement and prepare a balance sheet that includes prepare a balance sheet that includes fixed assets and intangible assets.fixed assets and intangible assets.

7.7. Describe and illustrate the fixed asset Describe and illustrate the fixed asset turnover ratio to assess the efficiency of a turnover ratio to assess the efficiency of a company’s use of its fixed assets.company’s use of its fixed assets.


Learning Learning Objective

ObjectiveDefine, classify, and account for

Define, classify, and account for

the cost of fixed assets

the cost of fixed assets

11


Nature of Fixed AssetsNature of Fixed Assets

o Fixed assetsFixed assets are long-term or relatively are long-term or relatively permanent assets, such as equipment, permanent assets, such as equipment, machinery, buildings, and land. Other machinery, buildings, and land. Other descriptive titles for fixed assets are descriptive titles for fixed assets are plant plant assetsassets or or property, plant, andproperty, plant, and equipmentequipment..


Nature of Fixed AssetsNature of Fixed Assets

o Fixed assets have the following Fixed assets have the following characteristics:characteristics: They exist physically and, thus, are They exist physically and, thus, are

tangibletangible assets. assets.

They are owned and used by the company They are owned and used by the company in its normal operations.in its normal operations.

They are not offered for sale as part of They are not offered for sale as part of normal operations.normal operations.

NATURE OF NATURE OF FIXED ASSETSFIXED ASSETS

CLASSIFYING CLASSIFYING COSTSCOSTS


Costs of Acquiring Fixed AssetsCosts of Acquiring Fixed Assets

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

Mistakes in installationMistakes in installation

Uninsured theftUninsured theft

Damage during unpacking and installingDamage during unpacking and installing

Fines for not obtaining proper permits Fines for not obtaining proper permits from government agenciesfrom government agencies


Capital and Revenue ExpendituresCapital and Revenue Expenditures

o Expenditures that benefit only the current Expenditures that benefit only the current period are called period are called revenue expendituresrevenue expenditures. .


Capital and Revenue ExpendituresCapital and Revenue Expenditures

o Expenditures that improve the asset or Expenditures that improve the asset or extend its useful life are extend its useful life are capital capital expendituresexpenditures..

CAPITAL AND REVENUE CAPITAL AND REVENUE EXPENDITURESEXPENDITURES

Revenue Revenue ExpendituresExpenditures

Normal and Normal and ordinary repairs ordinary repairs and maintenanceand maintenance

Capital Capital Expenditures Expenditures

Additions, Additions, improvements, improvements, and extraordinary and extraordinary repairsrepairs


Ordinary Maintenance and RepairsOrdinary Maintenance and Repairs

o On April 9, the firm paid $300 for a tune-On April 9, the firm paid $300 for a tune-up of a delivery truck.up of a delivery truck.

revenue expenditure


Asset ImprovementsAsset Improvements

o On May 4, a $5,500 hydraulic lift was On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for installed on the delivery truck to allow for easier and quicker loading of heavy cargo.easier and quicker loading of heavy cargo.

capital expenditure


capital expenditure

Extraordinary RepairsExtraordinary Repairs

o The engine of a forklift that is near the end The engine of a forklift that is near the end of its useful life is overhauled at a cost of of its useful life is overhauled at a cost of $4,500, which extends its useful life by $4,500, which extends its useful life by eight years. Work on the forklift was eight years. Work on the forklift was completed on October 14.completed on October 14.

CAPITAL AND CAPITAL AND REVENUE REVENUE

EXPENDITURESEXPENDITURES


Leasing Fixed AssetsLeasing Fixed Assets

o The two parties to a lease contract are as The two parties to a lease contract are as follows:follows: The lessor is the party who owns the asset.The lessor is the party who owns the asset.

The lessee is the party to whom the rights to The lessee is the party to whom the rights to use the asset are granted by the lessor.use the asset are granted by the lessor.



o A A capital leasecapital lease is accounted for as if the is accounted for as if the lessee has, in fact, purchased the asset. lessee has, in fact, purchased the asset. The asset is then amortized (written off as The asset is then amortized (written off as an expense) over the life of the capital an expense) over the life of the capital lease.lease.



o A lease that is not classified as a capital A lease that is not classified as a capital lease for accounting purposes is classified lease for accounting purposes is classified as an as an operating leaseoperating lease. An operating lease . An operating lease is treated as an expense, because the is treated as an expense, because the lessee is renting the asset for the lease lessee is renting the asset for the lease term.term.



ObjectiveCompute depreciation, using the

Compute depreciation, using the

following methods: straight-line

following methods: straight-line

method, units-of-production method,

method, units-of-production method,

and double-declining-balance method

and double-declining-balance method

22


DepreciationDepreciation

o Over time, most fixed assets (equipment, Over time, most fixed assets (equipment, buildings, and land improvements) lose buildings, and land improvements) lose their ability to provide services. The their ability to provide services. The periodic recording of the cost of fixed periodic recording of the cost of fixed assets as an expense is called assets as an expense is called depreciationdepreciation..


Accounting for DepreciationAccounting for Depreciation

o Depreciation can be caused by physical or Depreciation can be caused by physical or functional factors.functional factors.

Physical depreciationPhysical depreciation factors include factors include wear and tear during use or from wear and tear during use or from exposure to the weather.exposure to the weather.

Functional depreciationFunctional depreciation factors include factors include obsolescence and changes in customer obsolescence and changes in customer needs that cause the asset to no longer needs that cause the asset to no longer provide services for which it was provide services for which it was intended.intended.


Accounting for DepreciationAccounting for Depreciation

o Two common misunderstandings that Two common misunderstandings that exist about exist about depreciationdepreciation as used in as used in accounting include:accounting include: Depreciation does not measure a decline Depreciation does not measure a decline

in the market value of a fixed asset.in the market value of a fixed asset.

Depreciation does not provide cash to Depreciation does not provide cash to replace fixedreplace fixed assets as they wear out.assets as they wear out.


Factors in Computing DepreciationFactors in Computing Depreciation

o Three factors determine the depreciation Three factors determine the depreciation expense for a fixed asset. These three expense for a fixed asset. These three factors are:factors are:

The asset’s initial costThe asset’s initial cost

The asset’s expected useful lifeThe asset’s expected useful life

The asset’s estimated residual valueThe asset’s estimated residual value


Factors in Computing DepreciationFactors in Computing Depreciation

o The The expected useful lifeexpected useful life of a fixed asset is of a fixed asset is estimated at the time the asset is placed estimated at the time the asset is placed into service. The into service. The residual valueresidual value of a fixed of a fixed asset at the end of its useful life is also asset at the end of its useful life is also estimated at the time the asset is placed estimated at the time the asset is placed into service.into service.

FACTORS IN FACTORS IN COMPUTING COMPUTING

DEPRECIATIONDEPRECIATION


Straight-Line MethodStraight-Line Method

o The The straight-line methodstraight-line method provides for the provides for the same amount of depreciation expense for same amount of depreciation expense for each year of the asset’s useful life.each year of the asset’s useful life.

Annual Depreciation

Cost – Residual Value

Useful Life=


Annual Depreciation =Cost – Residual Value

Useful Life

$24,000 - $2,000

5 years=

= $4,400$4,400


Initial cost: $24,000Initial cost: $24,000

Expected useful lifeExpected useful life 5 years5 years

Estimated residual value: $2,000Estimated residual value: $2,000

o The annual straight-line depreciation of The annual straight-line depreciation of $4,400 is computed below:$4,400 is computed below:


$4,400 x 3/12 = $1,100$1,100


o If the preceding equipment was purchased If the preceding equipment was purchased and placed into service on October 1, the and placed into service on October 1, the depreciation for the first year of use would depreciation for the first year of use would be $1,100, computed as follows:be $1,100, computed as follows:



o The straight-line percentage can be The straight-line percentage can be determined by dividing 100% by the determined by dividing 100% by the number of years of expected useful life, number of years of expected useful life, as shown below.as shown below.


Units-of-Production MethodUnits-of-Production Method

o The The units-of-production methodunits-of-production method provides provides the same amount of depreciation expense the same amount of depreciation expense for each unit produced or each unit of for each unit produced or each unit of capacity used by the asset.capacity used by the asset. Step 1.Step 1. Determine the depreciation per unit Determine the depreciation per unit

as:as:

Step 2.Step 2. Compute the depreciation expense Compute the depreciation expense as:as:Depreciation Expense =

Depreciation per Unit x Total Units of Output Used

Depreciation per Unit =

Cost – Residual Value

Total Units of Production



o A depreciable asset costs $24,000. Its A depreciable asset costs $24,000. Its estimated residual value is $2,000, and it estimated residual value is $2,000, and it is expected to have a useful life of 10,000 is expected to have a useful life of 10,000 operating hours. During the year, the operating hours. During the year, the asset was operated 2,100 hours.asset was operated 2,100 hours.


Double-Declining-Balance MethodDouble-Declining-Balance Method

o The The double-declining-balance methoddouble-declining-balance method provides for a declining periodic expense provides for a declining periodic expense over the expected useful life of the asset.over the expected useful life of the asset.


(continued)


o The double-declining-balance method is The double-declining-balance method is applied in three steps:applied in three steps: Step 1.Step 1. Determine the straight-line Determine the straight-line

percentage using the expected useful life.percentage using the expected useful life.

Step 2.Step 2. Determine the double-declining-Determine the double-declining-balance rate by multiplying the straight-line balance rate by multiplying the straight-line rate from Step 1 by 2.rate from Step 1 by 2.

Step 3.Step 3. Compute the depreciation expense Compute the depreciation expense by multiplying the double-declining-balance by multiplying the double-declining-balance rate from Step 2 times the book value of the rate from Step 2 times the book value of the asset.asset.



o The double-declining-balance rate is The double-declining-balance rate is determined by doubling the straight-line determined by doubling the straight-line rate. rate.

o A shortcut to determining the straight-line A shortcut to determining the straight-line rate is to divide one by the number of rate is to divide one by the number of years (for example, 1 ÷ 5 = 0.20). years (for example, 1 ÷ 5 = 0.20).

o Using the double-declining-balance Using the double-declining-balance method, a five-year life results in a 40 method, a five-year life results in a 40 percent rate (0.20 × 2).percent rate (0.20 × 2).



o For the first year, the book value of the For the first year, the book value of the equipment is its initial cost of $24,000. equipment is its initial cost of $24,000.

o After the first year, the After the first year, the book valuebook value (cost (cost minus accumulated depreciation) declines minus accumulated depreciation) declines and, thus, the depreciation also declines.and, thus, the depreciation also declines.



o The double-declining-balance depreciation The double-declining-balance depreciation for the full five-year life of the equipment for the full five-year life of the equipment is shown below.is shown below.

DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE!

STOPSTOP

Desired ending

book value

“Forced” depreciation for 5th year




o If the preceding equipment was If the preceding equipment was purchased and placed into service on purchased and placed into service on October 1, depreciation for the year October 1, depreciation for the year ending December 31 would be $2,400, ending December 31 would be $2,400, computed as follows:computed as follows:

= $9,600 x 3/12 = $2,400First year partial

depreciation


= [40% x ($24,000 – $2,400)]Second year depreciation

= $8,640$8,640Second year depreciation


o The depreciation for the second year The depreciation for the second year would then be $8,640, computed as would then be $8,640, computed as follows:follows:



o The double-declining-balance method The double-declining-balance method provides a higher depreciation in the first provides a higher depreciation in the first year of the asset’s use, followed by year of the asset’s use, followed by declining depreciation amounts. Thus, it is declining depreciation amounts. Thus, it is called an called an accelerated depreciation accelerated depreciation methodmethod..

Comparing Depreciation MethodsComparing Depreciation Methods


Depreciation for Federal Income TaxDepreciation for Federal Income Tax

o The Internal Revenue Code specifies the The Internal Revenue Code specifies the Modified Accelerated Cost RecoveryModified Accelerated Cost Recovery System (MACRS)System (MACRS) for use by businesses in for use by businesses in computing depreciation for tax purposes.computing depreciation for tax purposes.



o MACRS specifies eight classes of useful MACRS specifies eight classes of useful life and depreciation rates for each of the life and depreciation rates for each of the eight classes. The two most common eight classes. The two most common classes are the five-year class (includes classes are the five-year class (includes automobiles and light-duty trucks) and automobiles and light-duty trucks) and the seven-year class (includes most the seven-year class (includes most machinery and equipment).machinery and equipment).



o For the five-year-class assets, For the five-year-class assets, depreciation is spread over six years, as depreciation is spread over six years, as shown below.shown below.


Revising Depreciation EstimatesRevising Depreciation Estimates

o A machine is purchased on January 1, A machine is purchased on January 1, 2013, for $140,000. 2013, for $140,000.



o At the end of 2014, the asset’s book value At the end of 2014, the asset’s book value is $88,000, as shown below.is $88,000, as shown below.



o During 2015, the company estimates that During 2015, the company estimates that the machine’s remaining useful life is eight the machine’s remaining useful life is eight years (instead of three) and that its residual years (instead of three) and that its residual value is $8,000 (instead of $10,000). value is $8,000 (instead of $10,000). Depreciation expense for each of the Depreciation expense for each of the remaining eight years is determined as remaining eight years is determined as follows:follows:

REVISING REVISING DEPRECIATION DEPRECIATION

ESTIMATESESTIMATES



ObjectiveJournalize entries for the

Journalize entries for the

disposal of fixed assets

disposal of fixed assets

33


Discarding Fixed AssetsDiscarding Fixed Assets

o Equipment acquired at a cost of $25,000 Equipment acquired at a cost of $25,000 is fully depreciation at December 31, is fully depreciation at December 31, 2013. On February 14, 2014, the 2013. On February 14, 2014, the equipment is discarded.equipment is discarded.



o Equipment costing $6,000, with no Equipment costing $6,000, with no residual value, is depreciated at an annual residual value, is depreciated at an annual straight-line rate of 10%. After the straight-line rate of 10%. After the December 31, 2013, adjusting entry, December 31, 2013, adjusting entry, Accumulated Depreciation—Equipment Accumulated Depreciation—Equipment has a $4,650 balance. On March 24, 2014, has a $4,650 balance. On March 24, 2014, the asset is removed from service and the asset is removed from service and discarded.discarded.


$600 × 3/12



o The discarding of the equipment is then The discarding of the equipment is then recorded as shown below. (Note that this is recorded as shown below. (Note that this is the second of two entries on March 24.)the second of two entries on March 24.)


Selling Fixed AssetsSelling Fixed Assets

o Equipment was purchased at a cost of Equipment was purchased at a cost of $10,000. It had no estimated residual $10,000. It had no estimated residual value and was depreciated at a straight-value and was depreciated at a straight-line rate of 10%. The equipment is sold for line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of cash on October 12 of the eighth year of its use. The balance of the accumulated its use. The balance of the accumulated depreciation account as of the preceding depreciation account as of the preceding December 31 is $7,000.December 31 is $7,000.

(continued)


(continued)


o The entry to update the depreciation for The entry to update the depreciation for the nine months of the current year is as the nine months of the current year is as follows:follows:



o After the current depreciation is recorded, After the current depreciation is recorded, the book value of the asset is $2,250 the book value of the asset is $2,250 ($10,000 – $7,750).($10,000 – $7,750).



ObjectiveCompute depletion and

Compute depletion and

journalize the entry for depletion

journalize the entry for depletion

44


Natural ResourcesNatural Resources

o The process of transferring the cost of The process of transferring the cost of natural resources to an expense account natural resources to an expense account is called is called depletiondepletion..



Step 1:Step 1: Determine the depletion rate as:Determine the depletion rate as:

Step 2:Step 2: Multiply the depletion rate by the Multiply the depletion rate by the

quantity extracted during the quantity extracted during the

period.period.



o A company paid $400,000 for the mining A company paid $400,000 for the mining rights to a mineral deposit estimated at rights to a mineral deposit estimated at 1,000,000 tons of ore. During the year, 1,000,000 tons of ore. During the year, the company mined 90,000 tons of the the company mined 90,000 tons of the mineral deposit.mineral deposit.



o The depletion expense for the year is The depletion expense for the year is computed as shown below.computed as shown below. Step 1.Step 1.

Step 2.Step 2.



o The adjusting entry to record the The adjusting entry to record the depletion is shown below.depletion is shown below.



ObjectiveDescribe the accounting for

Describe the accounting for

intangible assets, such as

intangible assets, such as

patents, copyrights, and goodwill

patents, copyrights, and goodwill

55


Intangible AssetsIntangible Assets

o Patents, copyrights, trademarks, and Patents, copyrights, trademarks, and goodwill are long-lived assets that are goodwill are long-lived assets that are used in the operations of a business and used in the operations of a business and not held for sale. These assets are called not held for sale. These assets are called intangible assetsintangible assets because they do not because they do not exist physically.exist physically.


Intangible AssetsIntangible Assets

o The accounting for intangible assets is The accounting for intangible assets is similar to that for fixed assets. The major similar to that for fixed assets. The major issues are:issues are: Determining the initial cost.Determining the initial cost.

Determining the Determining the amortizationamortization, which is the , which is the amount of cost to transfer to expense.amount of cost to transfer to expense.


PatentsPatents

o The exclusive right granted by the federal The exclusive right granted by the federal government to produce and sell goods government to produce and sell goods with one or more unique features is called with one or more unique features is called a a patentpatent. These rights continue in effect . These rights continue in effect for 20 years.for 20 years.


PatentsPatents

o At the beginning of its fiscal year, a At the beginning of its fiscal year, a business acquires patent rights for business acquires patent rights for $100,000. The patent’s remaining useful $100,000. The patent’s remaining useful life is estimated at 5 years. The entry to life is estimated at 5 years. The entry to amortize the patent at the end of the year amortize the patent at the end of the year is as follows:is as follows:


PatentsPatents

o Because a patent (as well as other Because a patent (as well as other intangible assets) does not exist intangible assets) does not exist physically, it is acceptable to credit the physically, it is acceptable to credit the asset. This approach is different from asset. This approach is different from physical fixed assets, which require the physical fixed assets, which require the use of a contra asset account.use of a contra asset account.


Copyrights and TrademarksCopyrights and Trademarks

o The exclusive right granted by the federal The exclusive right granted by the federal government to publish and sell a literary, government to publish and sell a literary, artistic, or musical composition is called a artistic, or musical composition is called a copyrightcopyright. A copyright extends for 70 . A copyright extends for 70 years beyond the author’s death.years beyond the author’s death.


Copyrights and TrademarksCopyrights and Trademarks

o A A trademarktrademark is a unique name, term, or is a unique name, term, or symbol used to identify a business and its symbol used to identify a business and its products. Most businesses identify their products. Most businesses identify their trademarks with ® in their trademarks with ® in their advertisements and on their products. advertisements and on their products. Trademarks can be registered for 10 years Trademarks can be registered for 10 years and renewed for 10-year periods and renewed for 10-year periods thereafter.thereafter.


GoodwillGoodwill

o In business, In business, goodwillgoodwill refers to an refers to an intangible asset of a business that is intangible asset of a business that is created from such favorable factors as created from such favorable factors as location, product quality, reputation, and location, product quality, reputation, and managerial skill.managerial skill.


GoodwillGoodwill

o Generally accepted accounting principles Generally accepted accounting principles (GAAP) permit goodwill to be recorded in (GAAP) permit goodwill to be recorded in the accounts only if it is objectively the accounts only if it is objectively determined by a transaction.determined by a transaction.


GoodwillGoodwill

o A loss should be recorded if the business A loss should be recorded if the business prospects of an acquired firm (and the prospects of an acquired firm (and the acquired goodwill) become significantly acquired goodwill) become significantly impaired. Assume that on December 31, impaired. Assume that on December 31, FaceCard Company has determined that FaceCard Company has determined that $250,000 of the goodwill created from the $250,000 of the goodwill created from the purchase of Electronic Systems is purchase of Electronic Systems is impaired.impaired.

INTANGIBLE INTANGIBLE ASSET ASSET

DISCLOSUREDISCLOSURE

COMPARISON COMPARISON OF INTANGIBLE OF INTANGIBLE

ASSETSASSETS



ObjectiveDescribe how depreciation expense is

Describe how depreciation expense is

reported in an income statement and

reported in an income statement and

prepare a balance sheet that includes

prepare a balance sheet that includes

fixed assets and intangible assets

fixed assets and intangible assets

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Fixed and Intangible AssetsFixed and Intangible Assets


Fixed and Intangible AssetsFixed and Intangible Assets

o Intangible assets are usually reported in Intangible assets are usually reported in the balance sheet in a separate section the balance sheet in a separate section following fixed assets.following fixed assets.

o The balance of each class of intangible The balance of each class of intangible assets should be disclosed net of any assets should be disclosed net of any amortization.amortization.

o The cost and related accumulated The cost and related accumulated depletion of mineral rights are normally depletion of mineral rights are normally shown as part of the Fixed Assets section shown as part of the Fixed Assets section of the balance sheet. of the balance sheet.



ObjectiveDescribe and illustrate the fixed

Describe and illustrate the fixed

asset turnover ratio to assess

asset turnover ratio to assess

the efficiency of a company’s

the efficiency of a company’s

use of its fixed assets

use of its fixed assets

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Fixed Asset Turnover RatioFixed Asset Turnover Ratio

o One measure of the revenue-generating One measure of the revenue-generating efficiency of fixed assets is the efficiency of fixed assets is the fixed assetfixed asset turnover ratioturnover ratio. It measures the number of . It measures the number of dollars of revenue earned per dollar of dollars of revenue earned per dollar of fixed assets and is computed as follows:fixed assets and is computed as follows:

Fixed Asset Turnover

Ratio

Net Sales

Average Book Value of Fixed Assets

=


AppendixAppendix

Exchanging Exchanging

Similar Fixed

Similar Fixed

AssetsAssetsExchanging Exchanging

Similar Fixed

Similar Fixed

AssetsAssets

Exchanging Similar Fixed AssetsExchanging Similar Fixed Assets

1.1.Old equipment is often traded for new Old equipment is often traded for new equipment having a similar use. In such equipment having a similar use. In such cases, the seller allows the buyer a cases, the seller allows the buyer a trade-trade-in allowance in allowance for the old equipment traded for the old equipment traded in. in.

2.2.The remaining balance—the amount owedThe remaining balance—the amount owed—is either paid in cash or recorded as a —is either paid in cash or recorded as a liability. It is normally called liability. It is normally called bootboot..

(see next slide)

Gain on ExchangeGain on Exchange

Gain on ExchangeGain on Exchange


Loss on ExchangeLoss on Exchange

o This time assume that only a $675 trade-This time assume that only a $675 trade-in allowance was allowed toward the in allowance was allowed toward the purchase of the new equipment. Because purchase of the new equipment. Because the market value of the new equipment is the market value of the new equipment is $5,000, the cash paid on the exchange is $5,000, the cash paid on the exchange is $4,325.$4,325.

Loss on ExchangeLoss on Exchange


Fixed Assets and

Fixed Assets and

Intangible Intangible

AssetsAssets

The EndThe EndThe EndThe End

Ch09 wrd12e instructor_final

Education

Transcript of Ch09 wrd12e instructor_final