BACCT1201 • Financial Accounting
LECTURE 5
Fixed Assets
Issah Hamdu
Faculty of Business Management and Globalization
Tel : 603 8317 8833 (Ext 8403)
Email: issah@limkokwing.edu.my
Objectives
• At the end of the lecture, students should
be able to:
• Explain with examples what is fixed assets
/plant assets/long-term assets.
• Define, explain and demonstrate how to
compute depreciation expense using various
methods of depreciation.
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Objectives....
• Explain the impact of various depreciation
methods on income statement. To let
students realized that depreciation is a
discretionary management policies.
• Explain why the Inland Revenue Dept. does
not recognize depreciation but only gives
recognition to their prescribed capital
allowance rates.
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Acquisition and Use of Long-Term
Operational Assets
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Learning
Objective 1Classification
of Operational Assets
Operational assets are used by a
business to generate revenue.
Tangible operational assets
have physical substance.
Land, buildings,
fixtures, and equipment
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Long-term Operational Assets
Long-term assets will be used
more than one year.
Tangible operational assets are
reported on the balance sheet in a
classification called:
Property, Plant, and Equipment.
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Classification of Operational Assets
Intangible operational assets
lack physical substance and
confer specific use rights on
the owner.
Patents
 Copyrights
 Franchises
 Licenses
 Trademarks

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Measuring and Recording
Acquisition Cost
Purchased operational assets are recorded at
cost, an amount that includes all normal and
reasonable expenditures necessary to get the
asset in place and ready for its intended use.
Invoice price
Sales taxes
Transportation costs
Installation costs
Renovation and repair cost incurred prior to use.
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Measuring Acquisition Cost
Acquisition cost is the net cash
equivalent amount paid for the asset.
Financing charges are
excluded from the
acquisition cost but
should be reported as
interest expense.
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Basket Purchase of Acquisitions
When land and building are purchased
together, the land cost and the building cost
are placed in separate accounts.
The total cost of the purchase is separated on
the basis of relative market values.
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Basket Purchase of Acquisitions
Example: Suppose a company purchased
land and a building for RM100,000 cash. The
appraised value of the building was
RM90,000, and the land was appraised at
RM30,000. How much of the RM100,000
purchase price will be allocated to each
account?
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Basket Purchase of
Acquisitions
Fair Market Values:
Building
Land
RM 90,000
RM 30,000
Total market value
RM120,000
Allocation of cost:
Building
Land
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90,000/120,000 = 3/4
30,000/120,000 = 1/4
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Basket Purchase of Acquisitions
Fair Market Values:
Building
Land
RM 90,000
RM 30,000
Total market value
RM120,000
Allocation of cost:
Building
Land
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3/4 X RM100,000 = RM75,000
1/4 X RM100,000 = RM25,000
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Learning
Objective 2
Depreciation, Depletion, and
Amortization
The matching principle requires that part of the
acquisition cost be expensed in periods when
the future revenues are earned.
Capitalize
...as the asset
is used.....
Cost of asset
on Balance
Sheet
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Expense
Expense on
Income
Statement
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Terminology: Write-off….amortize
The most general term for writing off an asset is amortization.
However, specific terms are used for certain assets:
Amortization:
Intangible assets
Depreciation:
Property, plant,
equipment
Depletion:
franchise
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–Natural resources
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Depreciation Methods
Straight-line
Units of production method
(Double) Declining balance
Depreciation
Expense per Year
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=
Cost - Residual Value
Life in Years
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Straight-Line Method: Example
On January 1, 2003, a juice machine was purchased for
RM11,500 cash. The equipment has an estimated
useful life of 6 years and an estimated residual value of
$500. Delivery and installation costs are RM1,000.
What is the annual straight-line depreciation expense?
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Straight-Line Method: Example
Cost = all costs to prepare machine for use.
Acquisition plus delivery and installation costs.
Depreciation
Expense per Year
=
Depreciation
Expense per Year
=
Depreciation
Expense per Year
=
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Cost - Residual Value
Life in Years
RM12,500 – 500
6
RM2,000
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Straight-Line Method: Example
Accumulated depreciation amounts are identical
to the amount of depreciation expensed each
year. However, the accumulated depreciation
account will increase each year by:
RM2000
The Accumulated depreciation account
balance at the end of the second year is:
RM4,000.
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Units-of-Production Method
Step 1:
Depreciation
Rate
Acquisition Cost - Salvage Value
Estimated units of useful life
=
Step 2:
Depreciation
Expense
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=
Depreciation
×
Rate
Financial Accounting
Number of
Units Produced
for the Year
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Units-of-Production Method
We will use the same information from the
previous example [a juice machine was purchased
for $11,500 cash. The equipment has an estimated
useful life of 6 years and an estimated residual
value of $500. Delivery and installation costs are
$1,000].
It is estimated that the machine will squeeze
240,000 glasses of juice over its useful life.
What is the depreciation rate per glass?
If 36,000 glasses were squeezed the first year,
what is the amount of the depreciation expense
for the year?
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Production Method:
Example
Step 1: Calculate the per glass rate.
12,000
Depreciation = Cost - salvage value
=
= $0.05
Rate
Total Productive output
240,000 glasses
Step 2: Calculate the annual depreciation expense.
Dep. rate X units produced this year
Depreciation
Expense = $ 0.05/glass * 36,000 glasses = $1,800
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Accelerated Depreciation
Accelerated depreciation methods result
in more depreciation expense in the early
years of an asset’s useful life and less
depreciation expense in later years of the
an asset’s useful life.
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Double-Declining Balance Method
Declining-balance depreciation is based
on the straight-line rate multiplied by an
acceleration factor.
For example, when the acceleration
factor is 200 percent, the method is
referred to as double-declining
balance depreciation.
Declining-balance depreciation
computations ignore residual value,
although the asset can’t be depreciated
below the residual value.
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Double-Declining Balance Method
The annual depreciation amount is
calculated with the following formula:
First, calculate a rate by multiplying the book value
by [2 divided by the number of years of useful life].
Book Value ×
(
2
Useful Life in Years
)
= Yearly depreciation expense
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Double-Declining-Balance Example
We will use the same information from the previous
example [a juice machine was purchased for $11,500
cash. The equipment has an estimated useful life of 6
years and an estimated residual value of $500.
Delivery and installation costs are $1,000].
Calculate the depreciation expense
for the first two years of the asset’s life.
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Double-Declining-Balance Example
Rate = 2/6 = 1/3 year
First year’s depreciation:
$12,500 X 1/3 =
$4,167
Second year’s depreciation:
Cost - previous year’s depreciation expense:
$12,500 - $4,167 = $8,333
$8,333 X 1/3 = $2,778 (rounded)
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Comparison of Methods
•The
total amount of depreciation recorded over the
useful life of an asset is the same regardless of the
method used.
•Depreciation
expense recorded in any one period
will vary according to method used.
•The
straight-line method is used by about 95
percent of companies because it is easy to use and
to explain.
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Natural Resources
A depletion rate is calculated using
the units-of-production method.
Depletion Cost Per Unit Is Calculated As Follows:
Total Cost of Natural Resource
Estimated Number of Available Units
of Natural Resource
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Natural Resources
Total cost of the asset is the cost of
acquisition, exploration and development.
Total cost is apportioned by means of
depletion over periods in which resulting
revenues are earned.
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Natural Resources
Assets supplied by nature
Examples: gold, oil, and coal
Presented on balance sheet as
non-current assets at cost less
depletion to date.
Depletion is just like “units of
production” depreciation.
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Learning
Objective 3
Intangible Assets
Noncurrent assets without physical substance
that confer certain rights and privileges on the
owner of the asset.
Examples: patents, copyrights, franchises
and licenses, leaseholds, leasehold
improvements, trademarks, and goodwill.
Purchased intangible assets are recorded at cost.
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Intangible Assets
Purchased intangible assets are amortized
over the shorter of their useful life or legal
life, whichever is longer.
Normally the straight-line method is used
and the asset is reported in the balance
Patent
sheet at book value.
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Intangible Assets
Intangible assets such as Goodwill are subject to
Impairment: a permanent reduction in its market value.
The asset will be evaluated for any permanent decline in
value. The asset value will be reduced by the amount of
decline in value, and an expense will be recognized in the
income statement.
Impairment may be due to:
A downturn in the economy
A change in how the company uses the asset
A change in the business climate
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Learning
Objective 4
Accounting for Capital
Expenditures
Improve the quality?
Extend the life?
viewed as canceling some
of the previous depreciation
viewed as an additional
cost of the equipment
reduce accumulated
depreciation
Increases the cost of
the asset
new depreciation
amount will be calculated
new depreciation
amount will be calculated
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Accounting for Capital Expenditures
Expenditures made to keep an
asset in good working order are
expensed in the period in which
they are incurred.
Substantial costs spent to
improve the quality or extend the
life of an asset are capitalized.
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Revising Estimates of Salvage Value or
Useful Life
When an estimate is revised, no changes are made to
amounts reported in the past.
The new estimates are incorporated into the present
and future calculations only.
Depreciation amounts are revised using the book
value and the estimated useful life and salvage value
at beginning of the year of the revision.
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Learning
Objective 5
Disposal of Operational Assets
Voluntary disposal refers to
situations where a business gives up
ownership of an asset by:
Sale
Trade-in
Retirement
Involuntary disposal results
because of a casualty such as a fire
or an accident.
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Disposal of Operational Assets
1. Update the depreciation on the asset to
the date of disposal.
2. Compare the book value of the asset to the
cash proceeds from the disposal. If the
proceeds > book value, there is a gain on the
disposal. If the book value > proceeds, then
there is a loss on the sale.
3. Gains and losses go on the income statement.
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Disposal of Operational Assets
Compare cash received for the asset
with the asset’s book value (BV).
If cash greater than BV, record a gain.
If cash less than BV, record a loss.
If cash equals BV, no gain or loss.
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Asset Disposal: Example
Suppose you decide to sell
an asset for RM8,000 that
was purchased 7 years ago
for RM25,000 with
accumulated depreciation of
RM17,500.
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Asset Disposal: Example
Compare the Book Value (RM7,500 = RM25,00017,500) to the cash proceeds (RM8,000).
The difference is a gain or loss on the sale.
It is a gain because the proceeds of RM8,000 > BV
of RM7,500
RM500 gain is reported on the income statement.
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Asset Disposal: Example
Now suppose you sell the asset for $5,000.
Compare the Book Value (RM7,500 = RM25,000
17,500) to the cash proceeds (RM5,000).
The difference is a gain or loss on the sale.
This is a loss:
Book value of RM7500 > Proceeds of RM5,000
RM2500 loss is reported on the income statement.
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Learning
Objective 6
Presentation of Long-term
Assets
Balance Sheet
Long-term assets are shown on the balance
sheet valued at amortized or depreciated cost
which is the carrying value .
Carrying value is the difference between the
cost of the asset and its accumulated
depreciation.
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Presentation of Long-term Assets
Income Statement
The use of Long-term assets is shown on the
income statement with amortization or
depreciation expense. Gains and losses on
disposal of long-term assets are reported on the
income statement, too.
Statement of Cash Flows
The statement of cash flows will show any cash
expenditures for long-term assets or any cash
collected from the sale of long-term assets.
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Learning
Objective 8
Business Risk, Control, and
Ethics
Firms risk losing long-term assets due to theft especially for its
smaller, mobile, fixed assets. Even large assets are at risk for
damage due to vandalism, hurricanes, or terrorists’ activities.
Controls that safeguard assets and minimize these risks:
1. Physical controls such as locks on a warehouse door, video
cameras, security guards on duty, fences, and alarms.
2. Segregation of duties: People who are responsible for the record
keeping should be different than those who have physical control of
the assets to help assure complete and reliable record keeping.
3. Monitoring all controls to ensure that all controls are in place
and operating properly.
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Learning
Objective 8
Depreciation and Federal
Income Taxes
The accounting information a
company reports on its
financial statements is not the
same information it reports to
the IRS on its federal income
tax return.
For depreciating fixed assets,
corporations use a method
called the Modified Accelerated
Cost Recovery System
(MACRS). MACRS is allowed
for tax purposes but not GAAP.
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Depreciation and Federal Income Tax
Most corporations use the Modified
Accelerated Cost Recovery System
(MACRS) for tax purposes.
MACRS provides for rapid
write-off of an asset’s cost in
order to stimulate investment
in modern facilities.
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The End
End of Lecture 5
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