Chapter 10Fixed Assets and Intangible AssetsAccounting, 21st EditionWarren Reeve FessPowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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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.ObjectivesAfter studying this chapter, you should be able to:

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.Objectives

Nature of Fixed AssetsFixed assets are long term or relatively permanent assetsFixed 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.

Classifying CostsIs the purchased item long-lived?YesIs the asset used in a productive purpose?NoExpenseYesFixed AssetsNoInvestment

Purchase priceSales taxesPermits from government agenciesBrokers commissionsTitle feesSurveying feesLand

LandPurchase priceSales taxesPermits from government agenciesBrokers commissionsTitle feesSurveying feesDelinquent real estate taxesRazing or removing unwanted buildings, less the salvageGrading and levelingPaving a public street bordering the land

Architects feesEngineers feesInsurance costs incurred during constructionInterest on money borrowed to finance constructionWalkways to and around the buildingBuildings

BuildingsSales taxesRepairs (purchase of existing building)Reconditioning (purchase of an existing building)Modifying for usePermits from governmental agencies

Land ImprovementsTrees and shrubsFencesParking areasOutdoor lightingConcrete sewers and drainagePaved parking areas

Sales taxesFreightInstallationRepairs (purchase of used equipment)Reconditioning (purchase of used equipment)Machinery and Equipment

Machinery and EquipmentInsurance while in transitAssemblyModifying for useTesting for usePermits from governmental agencies

Cost of Acquiring Fixed Assets Excludes:Vandalism Mistakes in installationUninsured theftDamage during unpacking and installingFines for not obtaining proper permits from government agencies

Nature of DepreciationAll 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.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.

Depreciation Expense Factors

Straight-LineDeclining- BalanceOtherUnits-of-ProductionSource: Accounting Trends & Techniques, 56th. ed., American Institute of Certified Public Accountants, New York, 2002.Use of Depreciation Methods

FactsOriginal Cost....... $24,000Estimated Life in years..5 yearsEstimated Life in hours.. 10,000Estimated Residual Value...$2,000

Straight-Line Method Cost estimated residual valueEstimated life= Annual depreciation

Straight-Line Method $24,000 $2,0005 years= $4,400 annual depreciation

Straight-Line Rate $24,000 $2,0005 years = $4,400$4,400 $24,000= 18.3%

Straight-Line MethodThe 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.

1$24,000$24,000$4,400$19,600224,000$ 4,40019,6004,40015,200324,0008,800 15,200 4,400 10,800 424,00013,200 10,800 4,400 6,400524,00017,6006,4004,4002,000Accum. Depr.Book ValueDepr.Book Value at Beginningat BeginningExpenseat End YearCostof Yearof Year for Yearof YearCost ($24,000) Residual Value ($2,000)Estimated Useful Life (5 years)=Annual DepreciationExpense ($4,400)Straight-Line Method

Units-of-Production MethodCost estimated residual valueEstimated life in units, hours, etc.= Depreciation per unit, hour, etc.

$24,000 $2,000 10,000 hours= Depreciation per unit, hour, etc.= $2.20 per hourUnits-of-Production Method

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.Units-of-Production Method

Declining-Balance MethodStep 1Ignoring residual value, determine the straight-line rate= $4,800

Theres a shortcut. Simply divide one by the number of years (1 5 = .20).Declining-Balance Method

Double the straight-line rate.Step 2.20 x 2 = .40For 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.Declining-Balance Method

Build a table.Step 3Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600Declining-Balance Method$24,000 x .40

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,760Declining-Balance Method$14,400 x .40

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,640Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,184Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,18445,18440%2,07420,8903,110Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,18445,18440% 2,07420,8903,11053,11040%1,24422,1341,866Declining-Balance Method

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,18445,18440% 2,07420,8903,11053,11040%1,24422,1341,866Declining-Balance MethodIf 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.

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,18445,18440% 2,07420,8903,11053,110---1,110Declining-Balance Method$3,110 $2,000

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1$24,00040%$9,600$9,600$14,400214,40040%5,76015,3608,64038,64040%3,45618,8165,18445,18440% 2,07420,8903,11053,110---1,11022,0002,000Desired ending book valueDeclining-Balance Method

Comparing Straight-Line With the Declining-Balance MethodStraight-LineMethodDepreciation ($)5,0004,0003,0002,0001,0000Life (years)Declining-BalanceMethodLife (years) 1 2 3 4 1 2 3 4

Revising Depreciation EstimatesA 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$4,000 per year

Equipment130,000Accumulated Depreciation4,0004,0004,0004,0004,0004,0004,0004,0004,000 4,00040,000Before revisingBook value = $90,000Revising Depreciation 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.Revising Depreciation Estimates

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

EXPENDITUREIncreases operating efficiency or adds to capacity?Capital and Revenue Expenditures

LIABILITIESOWNERSEQUITYREVENUESASSETSEXPENSESCAPITAL EXPENDITURES1. Initial cost2. Additions3. Betterments4. Extraordinary repairsnet incomeCapital and Revenue Expenditures

LIABILITIESOWNERSEQUITYREVENUESASSETSEXPENSESnet incomeNormal and ordinary repairs and maintenanceREVENUE EXPENDITURESCapital and Revenue Expenditures

Accounting 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 its balance from the ledger.

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

Discarding Fixed AssetsFeb.14Accumulated Depr.Equipment25 000 00To write off fully depreciated equipment.Equipment 25 000 00

Equipment costing $6,000 is depreciation at an annual straight-line rate of 10%. After the adjusting entry, Accumulated DepreciationEquipment had a $4,750 balance. The equipment was discarded on March 24.Mar.24Depreciation Expense.Equipment150 00To record current depreciation on equipment discarded. Accum. DepreciationEquipment 150 00Discarding Fixed Assets$600 x 3/12

Equipment costing $6,000 is depreciation at an annual straight-line rate of 10%. After the adjusting entry, Accumulated DepreciationEquipment had a $4,750 balance. The equipment was discarded on March 24.Mar.24Accumulated Depr.Equipment4 900 00Loss on Disposal of Fixed Asset1 100 00To write off equipment discarded. Equipment 6 000 00Discarding Fixed Assets

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 Assets

Sale of Fixed AssetsEquipment 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.12Depreciation ExpenseEquipment750 00To record current depreciation on equipment sold.Accumulated Depr.Equipment 750 00$10,000 x x10%

Sale of Fixed AssetsAssumption 1: The equipment is sold for $2,250, so there is no gain or loss.Oct.12Cash2 250 00 Sold equipment.Accumulated Depr.Equipment 7 750 00Equipment 10 000 00

Sale of Fixed AssetsAssumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.Oct.12Cash1 000 00 Sold equipment.Accumulated Depr.Equipment 7 750 00Equipment 10 000 00 Loss on Disposal of Fixed Assets1 250 00

Sale of Fixed AssetsAssumption 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 Accumulated Depr.Equipment 7 750 00Oct.12Cash2 800 00

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 TradeTIA < Book Value = Loss on TradeGains are never recognized (not recorded).Losses must be recognized (recorded).Exchanges of Similar Fixed Assets

CASE ONE (GAIN):Trade-in allowance, $1,100 Cash paid, $3,900 ($5,000 $1,100)TIA > Book Value = Gain$1,100 $800 = $300Boot + Book = Cost of New Equipment $3,900 + $800 = $4,700List price of new equipment acquired$5,000Cost of old equipment traded in$4,000Accum. depreciation at date of exchange 3,200Book value at date of exchange$ 800Exchanges of Similar Fixed AssetsGains are not recognized for financial reporting.

Exchanges of Similar Fixed AssetsJune19Accumulated Depr.Equipment3 200 00Equipment (new equipment) 4 700 00Equipment (old equipment) 4 000 00Cash 3 900 00On June 19, equipment exchanged at a gain of $300.

CASE TWO (LOSS):Trade-in allowance, $2,000 Cash paid, $8,000 ($10,000 $2,000)TIA

Exchanges of Similar Fixed AssetsSept. 7Accumulated Depr.Equipment4 600 00Equipment (new equipment)10 000 00Loss on Disposal of Fixed Assets400 00On September 7, equipment exchanged at a loss of $400.Equipment (old equipment) 7 000 00Cash8 000 00

Natural Resources and DepletionDepletion is the process of transferring the cost of natural resources to an expense account.

Natural Resources and DepletionA 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 Resources and Depletion Adjusting Entry Accumulated Depletion36 000 00During the current year, 90,000 tons are mined. The periodic depletion is $36,000 (90,000 tons x $0.40).Dec. 31Depletion Expense36 000 00

Dec. 31Amortization Expense20,000Patents20,000 DateDescriptionDebitCreditIntangible Assets and AmortizationPaid $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

Discovery Mining Co.Partial Balance SheetDecember 31, 2006Accum.BookProperty, plant, and equipment: CostDepr.Value 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$1,629,000Intangible assets:Patents$ 75,000Goodwill 50,000 Total intangible assets$ 125,000 Land$ 30,000$ 30,000Buildings110,000$ 26,00084,000Factory equipment650,000192,000458,000Office equipment 120,000 13,000107,000$910,000$231,000$ 679,000Accum.Book Mineral deposits:CostDepr.Value

Ratio of Fixed Assets to Long-Term Liabilities (in millions)20022001Procter & GambleFixed assets (net)$13,349$13,095Long-term debt$11,201$9,792Use:To indicate the margin of safety to long-term creditors

The EndChapter 10