Chapter 10

Fixed Assets and Intangible Assets

Accounting, 21st Edition
Warren Reeve Fess
Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

PowerPoint Presentation by Douglas Cloud

Professor Emeritus of Accounting Pepperdine University

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Objectives
1. Define fixed assets and describe the accounting for their cost. this After studying 2. Compute depreciation, using the following chapter, you should methods: straight-line method, units-ofbe able production method, and to: 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.

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 of Fixed Assets

Fixed assets are long term or relatively permanent assets 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.

Classifying Costs
Is the purchased item long-lived? Yes Is the asset used in a productive purpose? Yes No No

Expense

Fixed Assets

Investment

Land
Purchase price Sales taxes Permits from government agencies Brokers commissions Title fees Surveying fees

Land
Purchase price Delinquent real estate taxes Sales taxes from Razing or removing Permits government agencies unwanted buildings, less the salvage Brokers commissions Grading and leveling Title fees Paving a public street Surveying fees bordering the land

Buildings
Architects fees Engineers fees Insurance costs incurred

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

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 and Equipment

Sales taxes Freight Installation Repairs (purchase of used equipment) Reconditioning (purchase of used equipment)

Machinery and Equipment

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

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

Nature of Depreciation
All fixed assets except land lose their capacity to 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

Initial Cost

Residual Value

Depreciable Cost

Useful Life

Periodic Depreciation Expense

Use of Depreciation Methods

Declining4% Balance

Other Units-of-Production
8% 5%

83%

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

Facts
Original Cost.......
Estimated Life in years.. Estimated Life in hours.. Estimated Residual Value...

$24,000
5 years 10,000 $2,000

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

Straight-Line Method $24,000 $2,000 5 years

= $4,400 annual depreciation

Straight-Line Rate
$24,000 $2,000 5 years

= $4,400

$4,400 = 18.3% $24,000

Straight-Line Method
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.

Straight-Line Method
Year 1 2 3 4 5 Cost $24,000 24,000 24,000 24,000 24,000 Accum. Depr. at Beginning of Year Book Value at Beginning of Year $24,000 19,600 15,200 10,800 6,400 Depr. Expense for Year $4,400 4,400 4,400 4,400 4,400 Book Value at End of Year $19,600 15,200 10,800 6,400 2,000

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

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

Annual = Depreciation Expense ($4,400)

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

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

Units-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.

Declining-Balance Method
Step 1
Ignoring residual value, determine the straight-line rate
100% Usefull Life 100% 5 = x%

= 20%

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

Declining-Balance Method
Step 2
Double the straight-line rate.

.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.

Declining-Balance Method
Step 3

Build a table.

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

$24,000

40%

$9,600

$24,000 x .40

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

$24,000

40%

$9,600

$9,600

$14,400

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2

$24,000 14,400

40% 40%

$9,600 5,760

$9,600

$14,400

$14,400 x .40

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2

$24,000 14,400

40% 40%

$9,600 5,760

$9,600 15,360

$14,400 8,640

Declining-Balance Method
Year 1 2 3 Book Value Beginning of Year Rate $24,000 14,400 8,640 40% 40% 40% Annual Deprec. $9,600 5,760 3,456 Accum. Deprec. Year-End $9,600 15,360 18,816 Book Value Year-End $14,400 8,640 5,184

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2 3 4

$24,000 14,400 8,640 5,184

40% 40% 40% 40%

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

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

$14,400 8,640 5,184 3,110

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2 3 4 5

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

40% 40% 40% 40% 40%

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

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

$14,400 8,640 5,184 3,110 1,866

Declining-Balance Method
Year

If we use this approach in Year 5, we will Book Value Accum. end the year with a book value of $1,866. Beginning Annual Deprec. Book Value of Year Rate Deprec. value Year-End Remember, the residual at the endYear-End of Year 5 is expected to be $2,000, so we must $24,000 40% $9,600 $9,600 $14,400 modify our approach. 14,400 40% 5,760 15,360 8,640 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

1 2 3 4 5

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2 3 4 5

$24,000 14,400 8,640 5,184 3,110

40% 40% 40% 40% ---

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

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

$14,400 8,640 5,184 3,110

$3,110 $2,000

Declining-Balance Method
Year Book Value Beginning of Year Rate Annual Deprec. Accum. Deprec. Year-End Book Value Year-End

1 2 3 4 5

$24,000 14,400 8,640 5,184 3,110

40% 40% 40% 40% ---

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

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

$14,400 8,640 5,184 3,110 2,000

Desired ending book value

Comparing Straight-Line With the Declining-Balance Method

Straight-Line Method Declining-Balance Method

5,000

Depreciation ($)

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

1 2 3 Life (years)

1 2 3 Life (years)

Revising Depreciation Estimates

A machine purchased for Annual $130,000 was originally Depreciation estimated to have a useful $130,000 $10,000 life of 30 years and a 30 years residual value of $10,000. The asset has been $4,000 per year depreciated for ten years using the straightline method.

Revising Depreciation Estimates

Equipment 130,000
Accumulated Depreciation 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 40,000

Book value = $90,000

Before revising

Revising 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. Book value revised residual value Revised estimated remaining life $3,400 revised $90,000 $5,000 = annual depreciation 25 years

Capital and Revenue Expenditures

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

EXPENDITURE

Increases Increases operating useful life efficiency or adds No (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 and Revenue Expenditures

LIABILITIES

CAPITAL EXPENDITURES 1. Initial cost 2. Additions 3. Betterments 4. Extraordinary repairs

ASSETS

OWNERS EQUITY net income

EXPENSES

REVENUES

Capital and Revenue Expenditures

LIABILITIES ASSETS OWNERS EQUITY net income

REVENUE EXPENDITURES Normal and ordinary repairs and maintenance

EXPENSES

REVENUES

Accounting for Fixed Asset 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 its balance from the ledger.

Discarding Fixed Assets

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

Discarding Fixed Assets

Feb. 14 Accumulated Depr.Equipment
Equipment To write off fully depreciated equipment.

25 000 00
25 000 00

Discarding Fixed Assets

Equipment costing $6,000 is depreciation 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 Accum. DepreciationEquipment 150 00 150 00

To record current depreciation

on equipment discarded.

$600 x 3/12

Discarding Fixed Assets

Equipment costing $6,000 is depreciation 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 Loss on Disposal of Fixed Asset 4 900 00 1 100 00

Equipment
To write off equipment discarded.

6 000 00

Sale of Fixed 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 of Fixed Assets

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 ExpenseEquipment Accumulated Depr.Equipment To record current depreciation on equipment sold. 750 00 750 00

$10,000 x x10%

Sale of Fixed Assets

Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.
Oct. 12 Cash
Accumulated Depr.Equipment Equipment Sold equipment.

2 250 00
7 750 00 10 000 00

Sale of Fixed Assets

Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.
Oct. 12 Cash
Accumulated Depr.Equipment Loss on Disposal of Fixed Assets Equipment Sold equipment.

1 000 00
7 750 00 1 250 00 10 000 00

Sale of Fixed Assets

Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.
Oct. 12 Cash
Accumulated Depr.Equipment Equipment Gain on Disposal of Fixed Assets Sold equipment.

2 800 00
7 750 00 10 000 00 550 00

Exchanges 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).

Exchanges of Similar Fixed 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 are not TIA > Book Value = Gain recognized for $1,100 $800 = $300 financial reporting. Boot + Book = Cost of New Equipment $3,900 + $800 = $4,700

Exchanges of Similar Fixed Assets

On June 19, equipment exchanged at a gain of $300.
June 19 Accumulated Depr.Equipment 3 200 00

Equipment (new equipment)

Equipment (old equipment) Cash

4 700 00
4 000 00 3 900 00

Exchanges of Similar Fixed 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<Book Value = Loss Losses are $2,000 $2,400 = $400 recognized for

financial reporting.

Exchanges of Similar Fixed Assets

On September 7, equipment exchanged at a loss of $400.
Sept. 7 Accumulated Depr.Equipment 4 600 00

Equipment (new equipment)

Loss on Disposal of Fixed Assets Equipment (old equipment) Cash

10 000 00
400 00 7 000 00 8 000 00

Natural Resources and Depletion

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

Natural 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).

Natural Resources and 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

Debit Credit 20,000 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

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

Accum. Depr. $ 26,000 192,000 13,000 $231,000 Accum. Depr. $ 800,000 200,000 $1,000,000

Book Value $ 30,000 84,000 458,000 107,000 $ 679,000 Book Value $400,000 550,000

Mineral deposits: Alaska deposit Wyoming deposit

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

950,000 $1,629,000
$ 75,000 50,000 $ 125,000

Ratio of Fixed Assets to Long-Term Liabilities

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

2002
$13,349 $11,201

2001
$13,095 $9,792

Ratio of fixed assets to long-term liabilities

1.2

1.3

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

Chapter 10

The End