Chapter 10
Fixed assets and intangible assets
Learning Objectives
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Nature of Fixed Assets
Accounting for Depreciation
Capital and Revenue Expenditures
Disposal of Fixed Assets
Leasing Fixed Assets
Internal Control of Fixed Assets
Natural Resources
Intangible Assets
Financial Reporting
Financial Analysis and Interpretation
C10 - 1
Nature of Fixed Assets
Fixed assets are longterm, relatively permanent,
tangible assets such as
buildings and equipment
used to help produce
revenues.
ASSETS
Fixed
Assets
EXPENSES
LIABILITIES
OWNER’S
EQUITY
REVENUES
C10 - 2
Nature of Fixed Assets
Fixed assets are longterm, relatively permanent,
tangible assets such as
buildings and equipment
used to help produce
revenues.
All fixed assets except
land lose their capacity
to provide services.
This loss of productive
capacity is recognized as
depreciation expense.
ASSETS
Fixed
Assets
EXPENSES
LIABILITIES
OWNER’S
EQUITY
REVENUES
C10 - 3
Costs of Acquiring Fixed Assets Include:

Sales tax and freight costs

Installation and assembling

Repairs and reconditioning (used assets)

Testing and modifying

Insurance while asset is in transit
C10 - 4
Costs of Acquiring Fixed Assets Exclude:


Vandalism
uninsured theft

Mistakes in installation

Damage during unpacking and installing

fines
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Factors that Determine Depreciation Expense
a
Initial Cost $24,000
minus
C10 - 6
Factors that Determine Depreciation Expense
a
Initial Cost $24,000
minus
b Estimated Residual Value $2,000
equals
C10 - 7
Factors that Determine Depreciation Expense
a
Initial Cost $24,000
minus
b Estimated Residual Value $2,000
equals
Depreciable Cost $22,000
divided by
C10 - 8
Factors that Determine Depreciation Expense
a
Initial Cost $24,000
minus
b Estimated Residual Value $2,000
equals
Depreciable Cost $22,000
divided by
c
Estimated Useful Life 5 years
equals
C10 - 9
Factors that Determine Depreciation Expense
a
Initial Cost $24,000
minus
b Estimated Residual Value $2,000
equals
Depreciable Cost $22,000
divided by
c
Estimated Useful Life 5 years
equals
Periodic Depreciation Expense $4,400 per year
C10 - 10
Recording Depreciation
A Purchase equipment for $24,000. Estimated residual
value is $2,000 and useful life is 5 years.
B Record straight-line depreciation for first year.
General Ledger
General Journal
Description
A
Equipment
Cash
Debit
Credit
Equipment
A 24,000
24,000
24,000
Accum. Depreciation
B
Depreciation Expense
C10 - 11
Recording Depreciation
A Purchase equipment for $24,000. Estimated residual
value is $2,000 and useful life is 5 years.
B Record straight-line depreciation for first year.
General Ledger
General Journal
Description
A
Equipment
Cash
Debit
Credit
Equipment
A 24,000
24,000
24,000
Accum. Depreciation
B Depreciation Expense
Accum. Depreciation
4,400
4,400
Depreciation Expense
C10 - 12
Recording Depreciation
A Purchase equipment for $24,000. Estimated residual
value is $2,000 and useful life is 5 years.
B Record straight-line depreciation for first year.
General Ledger
General Journal
Description
A
Equipment
Cash
Debit
Credit
Equipment
A 24,000
24,000
24,000
Accum. Depreciation
B Depreciation Expense
4,400
Accum. Depreciation
4,400
Depreciation Expense
$24,000 - $2,000
= $4,400
5 years
C10 - 13
Recording Depreciation
A Purchase equipment for $24,000. Estimated residual
value is $2,000 and useful life is 5 years.
B Record straight-line depreciation for first year.
General Ledger
General Journal
Description
A
Equipment
Cash
Debit
Equipment
Credit
A 24,000
24,000
24,000
Accum. Depreciation
B Depreciation Expense
4,400
Accum. Depreciation
4,400
4,400
B
Depreciation Expense
$24,000 - $2,000
= $4,400
5 years
B
4,400
C10 - 14
Calculation of Book Value
General Ledger
Equipment
A 24,000
Accum. Depreciation
4,400
B
Depreciation Expense
B
4,400
C10 - 15
Calculation of Book Value
General Ledger
Equipment
Original Cost
Less Accum. Depr.
A 24,000
Accum. Depreciation
4,400
Book Value
$24,000
4,400
19,600
B
Depreciation Expense
B
4,400
C10 - 16
Depreciation Methods
The following four depreciation methods are
acceptable for Financial Accounting purposes:
1. Straight-Line
2. Units-of-Production
3. Declining-Balance
4. Sum-of-Years-Digits
Straight-line is far more widely used than other
methods.
Declining-balance and sum-of-years-digits are
known as accelerated depreciation methods.
C10 - 17
Straight - Line Depreciation
Year
Cost
1
2
3
4
5
$24,000
24,000
24,000
24,000
24,000
Accum. Depr. Book Value
at Beginning at Beginning
of Year
of Year
$ 4,400.00
8,800.00
13,200.00
17,600.00
$24,000.00
19,600.00
15,200.00
10,800.00
6,400.00
Cost ($24,000) - Residual Value ($2,000)
Estimated Useful Life (5 years)
Depr.
Expense
for Year
Book Value
at End
of Year
$4,400.00
4,400.00
4,400.00
4,400.00
4,400.00
$19,600.00
15,200.00
10,800.00
6,400.00
2,000.00
Annual Depreciation
=
Expense ($4,400)
C10 - 18
Declining - Balance Depreciation
Year Cost
1
2
3
4
5
$24,000
24,000
24,000
24,000
24,000
Accum. Depr.
at Beginning
of Year
$ 9,600.00
15,360.00
18,816.00
20,889.60
Book Value
at Beginning
of Year
Rate
$24,000.00
14,400.00
8,640.00
5,184.00
3,110.40
Depr. Book Value
Expense
at End
for Year
of Year
40%$9,600.00 $14,400.00
40% 5,760.00
8,640.00
40% 3,456.00
5,184.00
40% 2,073.60
3,110.40
––
1,110.40
2,000.00
Note the acceleration of depreciation
expense into early years of the life of the asset.
C10 - 19
Comparing Depreciation Methods
Straight-Line
Method
Declining-Balance
Method
Life (years)
Life (years)
Depreciation ($)
10,000
8,000
6,000
4,000
2,000
0
C10 - 20
Depreciation for Federal Income Tax
-the Modified Accelerated Cost Recovery System (MACRS)
5-year class
Year
1
2
3
4
5
6
Rate (%)
20
32
19.2
11.5
11.5
5.8
100%
Why
using MACRS
method
for both
financial statement
and tax purposes
may hurt a business?
C10 - 21
Revising Depreciation Estimates
Example: (P.397)
1.
2.
3.
4.
5.
6.
7.
8.
9.
Cost : $130,000
Residual value: $10,000
Depreciable cost: $120,000
Useful life: 30 years
Have Used for ten years
Net book value: $90,000
Revise for another 25 years, residual value: $5,000
Depreciable cost: $85,000
Revised annual depreciation expense: $3,400
C10 - 22
Capital and Revenue Expenditures
EXPENDITURE
Increases
operating
efficiency or
adds to
capacity?
Yes
Capital Expenditure
(Debit fixed asset
account)
C10 - 23
Capital and Revenue Expenditures
EXPENDITURE
Increases
operating
efficiency or
adds to
capacity?
No
Increases
useful life
(extraordinary
repairs)?
Yes
Capital Expenditure
(Debit fixed asset
account)
C10 - 24
Capital and Revenue Expenditures
EXPENDITURE
Increases
operating
efficiency or
adds to
capacity?
No
Yes
Capital Expenditure
(Debit fixed asset
account)
Increases
useful life
(extraordinary
repairs)?
Yes
Capital Expenditure
(Debit accumulated
depreciation account)
C10 - 25
Capital and Revenue Expenditures
EXPENDITURE
Increases
operating
efficiency or
adds to
capacity?
No
Yes
Capital Expenditure
(Debit fixed asset
account)
Increases
useful life
(extraordinary
repairs)?
Revenue
Expenditure
(Debit expense
No
account for
ordinary
maintenance
and repairs)
Yes
Capital Expenditure
(Debit accumulated
depreciation account)
C10 - 26
Capital and Revenue Expenditures
LIABILITIES
CAPITAL
EXPENDITURES
1. Initial cost
2. Additions
3. Betterments
4. Extraordinary
repairs
ASSETS
OWNER’S
EQUITY
net income
EXPENSES
REVENUES
C10 - 27
Capital and Revenue Expenditures
LIABILITIES
CAPITAL
EXPENDITURES
ASSETS
OWNER’S
EQUITY
net income
REVENUE
EXPENDITURES
EXPENSES
REVENUES
Normal and
ordinary repairs
and maintenance
C10 - 28
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:
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.
C10 - 29
Discarding Fixed Assets
Date
Description
Feb. 14 Accumulated Depreciation
Debit
Credit
25,000
Equipment
25,000
Write off fully depreciated equipment.
Mar. 24 Loss on Disposal of Equipment
Accumulated Depreciation
Equipment
1,100
4,900
6,000
Write off partially depreciated equipment.
C10 - 30
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.
C10 - 31
Selling Fixed Assets
1.
2.
3.
4.
5.
6.
7.
8.
Equipment Cost: $10,000
Depreciation rate: 10%/year
Depreciation expense: $1,000/year
Accumulated depreciation($1000*7): $7,000
To be sold on Oct. 12 of the eighth year of its use
Current year’s depreciation expense(1-9): $750
Book value of the asset: $ 2,250
If sold
•
•
•
At book value: $2,250
Below book value: $1,000, loss $1,250
Above book value: $2,800, gain $550
C10 - 32
Sale of Fixed Assets
Sold equipment with a book value of $2,250
(cost $10,000, accumulated depreciation $7,750).
Date
Oct. 12
Description
Debit
Credit
Cash
2,250
Accumulated Depreciation 7,750
Equipment
10,000
Sold at book value, for $2,250.
C10 - 33
Sale of Fixed Assets
Sold equipment with a book value of $2,250
(cost $10,000, accumulated depreciation $7,750).
Date
Description
Oct. 12 Cash
Loss on Disposal of Equipment
Accumulated Depreciation
Equipment
Debit
Credit
1,000
1,250
7,750
10,000
Sold below book value, for $1,000.
Cash
2,800
Oct. 12
Accumulated Depreciation
7,750
Equipment
10,000
Gain on Disposal of Equipment
550
Sold above book value, for $2,800.
C10 - 34
Exchanges of Similar Fixed Assets





Trade-in Allowance (TIA) – amount
allowed for old equipment toward the
purchase price of similar new assets.
TIA > Book Value = Gain on Trade
TIA < Book Value = Loss on Trade
Gains are never recognized (not
recorded).
Losses must be recognized
(recorded).
C10 - 35
Exchanges of Similar Fixed Assets
Quoted price of new equipment acquired
Cost of old equipment traded in
Accum. depreciation at date of exchange
Book value at date of exchange
Case One (GAIN)
Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100)
TIA > Book Value = Gain
$1,100 – $800 = $300
Cost of New Equipment
$3,900 + $800 = $4,700
$5,000
$4,000
3,200
$ 800
Gains are not
recognized for
financial reporting.
C10 - 36
Exchanges of Similar Fixed Assets
Quoted price of new equipment acquired
Cost of old equipment traded in
Accum. depreciation at date of exchange
Book value at date of exchange
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
Cost of New Equipment =
Quoted Price of New Asset $10,000
$10,000
$7,000
4,600
$ 2,400
Losses are
recognized for
financial
reporting.
C10 - 37
Leasing Fixed Assets
All leases are either capital leases or operating leases.
Capital leases include one or more of the following:
1. Lease transfers ownership to the lessee at the end of
the lease term.
2. An option for a bargain purchase by the lessee.
3. Lease term extends over most of the life of the asset.
4. Lease requires rental payments that approximate fair
market value of the asset.
Capital leases are accounted for as if the lessee has
purchased the asset. Lessee debits an asset account for
the fair market value and credits a long-term liability.
Operating leases are accounted for as rent expense.
C10 - 38
Natural Resources and Depletion
Depletion is the periodic allocation of the cost of metal
ores and other minerals removed from the earth.
Date
Description
Dec. 31 Depletion Expense
Accumulated Depletion
Debit
Credit
36,000
36,000
Paid $400,000 for the mining rights to a
mineral deposit estimated at 1,000,000 tons of
ore. During the year, 90,000 tons are mined.
($400,000 / 1,000,000 tons) = $0.40 per ton
90,000 tons x $0.40 = $36,000
C10 - 39
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
Debit
Credit
20,000
Patents
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
C10 - 40
Discovery Mining Co.
Balance Sheet
December 31, 20-Property, plant, and equipment:
Land
Buildings
Factory equipment
Office equipment
Mineral deposits:
Alaska deposit
Wyoming deposit
Cost
$ 30,000
110,000
650,000
120,000
$910,000
Cost
Accum.
Depr.
$ 26,000
192,000
13,000
$231,000
Accum.
Depl.
$1,200,000 $ 800,000
750,000
200,000
$1,950,000 $1,000,000
Total property, plant, and equipment
Intangible assets:
Patents
Goodwill
Total intangible assets
Book
Value
$ 30,000
84,000
458,000
107,000
$ 679,000
Book
Value
$400,000
550,000
950,000
$1,629,000
$ 75,000
50,000
$125,000
C10 - 41
Discovery Mining Co.
Balance Sheet
December 31, 20-Property, plant, and equipment:
Land
Buildings
Factory equipment
Office equipment
Mineral deposits:
Alaska deposit
Wyoming deposit
Cost
$ 30,000
110,000
650,000
120,000
$910,000
Cost
Accum.
Depr.
$ 26,000
192,000
13,000
$231,000
Accum.
Depl.
$1,200,000 $ 800,000
750,000
200,000
$1,950,000 $1,000,000
Total property, plant, and equipment
Intangible assets:
Patents
Goodwill
Total intangible assets
Book
Value
$ 30,000
84,000
458,000
107,000
$ 679,000
Book
Value
$400,000
550,000
950,000
$1,629,000
$ 75,000
50,000
$125,000
C10 - 42
Ratio of Fixed Assets to Long-Term Liabilities
Procter & Gamble
Property, plant, equip. (net)
Long-term liabilities (debt)
(in millions)
1996
1995
$11,118
$ 4,670
$11,026
$5,161
C10 - 43
Ratio of Fixed Assets to Long-Term Liabilities
Procter & Gamble
Property, plant, equip. (net)
Long-term liabilities (debt)
Ratio of fixed assets to
long-term liabilities
(in millions)
2000
1999
$11,118
$ 4,670
$12,626
$6,231
2.4
2.0
Use: To indicate the margin of safety
to long-term creditors
C10 - 44
HOME WORK
READING:
1. Illustrative problem
2. Self- examination questions
3. Multiple choice
Writing:
1. Exercise:
2. Problem : 10-2A
Discussion: Activity 10-2
C10 - 45
The end of chapter 10
C10 - 46