BY R A C H E L L E A G AT H A , C PA , M B A
Fixed Assets
Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac
2
1. Define, classify, and account for the cost of fixed assets.
2. Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method.
Objectives:
3
3. Journalize entries for the disposal of fixed assets.
4. Compute depletion and journalize the entry for depletion.
5. Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.
Objectives:
4
6. Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.
Objectives:
5
Define, classify, and account for the cost of
fixed assets.
Objective 1
Objective 1
6
Nature of Fixed Assets
Fixed assets are long-term or relatively permanent
assets. They are tangible assets because they exist
physically. They are owned and used by the business and
are not offered for sale as part of normal operations.
7
Fixed Assets as a Percent of Total Assets—Selected Companies
8
Is the purchased item long-lived?
yes
Is the asset used in a productive
purpose?
no
Expense
yes
Fixed Assets
no
Investment
Classifying Costs
9
Purchase price Sales taxes Permits from government
agencies Broker’s commissions Title fees Surveying fees Delinquent real estate taxes Razing or removing unwanted
buildings, less any salvage Grading and leveling Paving a public street
bordering the land
LAND
Cost of Acquiring Fixed Assets
10
Architects’ fees Engineers’ fees Insurance costs incurred during
construction Interest on money borrowed to
finance construction Walkways to and around the
building Sales taxes Repairs (purchase of existing
building) Reconditioning (purchase of
existing building) Modifying for use Permits from government agencies
BUILDING
Cost of Acquiring Fixed Assets
11
Sales taxes Freight Installation Repairs (purchase of
used equipment) Reconditioning
(purchase of used equipment)
Insurance while in transit
Assembly
Trees and shrubs Fences Outdoor lighting Paved parking
areas
Cost of Acquiring Fixed Assets
MACHINERY AND EQUIPMENT
LAND IMPROVEMENT
Modification for user Testing for use Permits from
government agencies
12
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
13
Expenditures that benefit only the current period are called
revenue expenditures. Expenditures that improve the asset or extend its useful life are capital expenditures.
Capital and Revenue Expenditures
14
CAPITAL EXPENDITURES1) Additions2) Improvements
3) Extraordinary
repairs
Normal and ordinary repairs and maintenance
REVENUE EXPENDITURES
Operating Expenses
15
Ordinary Maintenance and Repairs
On April 9, the firm paid $300 for a tune-up of a delivery truck.
Apr. 9 Repairs and Maintenance Exp.300 00Cash 300 00
This is a revenue expenditure/operating
exp
This is a revenue expenditure/operating
exp
16
Asset Improvements
On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo.
May 4 Delivery Truck 5 500 00Cash 5 500 00
This is a capital expenditure
This is a capital expenditure
17
Extraordinary Repairs
The engine of a forklift that is near the end of its useful life is overhauled at a cost of $4,500, which extends its useful life eight years. Work on the forklift was completed on Oct. 14.
Oct. 14 Accum. Depreciation—Forklift 4 500 00Cash 4 500 00
This is a capital expenditure
This is a capital expenditure
18
Capital or Revenue Expenditure
19
On June 18 GTS Co. paid $1,200 to upgrade a hydraulic lift and $45 for an oil change for one of its delivery trucks. Journalize the entries for the hydraulic lift upgrade and oil change expenditures.
19
June 18 Delivery Truck 1,200Cash 1,200
18 Repairs and Maintenance Exp. 45Cash 45
20
Leasing Fixed Assets
A capital lease is accounted for as if the
lessee has, in fact, purchased the asset.
The asset is then amortized over the life
of the capital lease.
21
Leasing Fixed Assets
A lease that is not classified as a
capital lease for accounting purposes is
classified as an operating lease
(an operating leases is treated as an
expense).
22
Compute depreciation using the following
methods: straight-line method, units-of-
production method, double-declining-balance
method.
Objective 2
Objective 2
23
Over time, fixed assets such as equipment, buildings, and
land improvements lose their ability to provide services. The periodic
transfer of the cost of fixed assets to expense is called
depreciation.
Accounting for Depreciation
24
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 no longer able to provide services at the level for
which it was intended.
Physical and Functional Depreciation
25
Factors in Computing Depreciation
The three factors in determining the amount of depreciation expense to be
recognized each period are: (a) the fixed asset’s initial cost, (b) its expected useful life, and (c)
its estimated value at the end of the useful life.
26
The fixed asset’s estimated value at the end of its useful
life is called the residual value, scrap value, salvage value, or trade-in value. A fixed asset’s residual value
and its expected useful life must be estimated at the time the asset is placed in service.
Residual Value
27
28
88%
2%
7% 3%
Source: Accounting Trends & Techniques, 59th ed., American Institute of Certified Public Accountants, New York, 2005.
Exhibit 5: Use of Depreciation Methods
Straight-line
Units-of-production
Double-declining-balance
Other
29
Straight-Line Method
The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life.
Annual depreciation =
Cost – est residual value Estimated life
30
A depreciable asset cost $24,000. Its estimated residual value is
$2,000 and its estimated life is 5 years.
Annual depreciation =
Cost – est residual valueEstimated life
Annual depreciation = $24,000 – $2,0005 years
Annual depreciation =$4,400
31
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.
32
Equipment that was acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (a) depreciable cost, (b) straight-line rate, and (c) annual straight-line depreciation.(a) $120,000 ($125,000 – $5,000)(b) 10% = (1/10)(c) $12,000 ($120,000 x 10%) or ($120,000
÷ 10 years)
33
Units-of-Production Method
The units-of-production method provides for the same amount of
depreciation expense for each unit produced or each unit of capacity used
by the asset.
Unit depreciation =Cost – estimated residual valueEstimated hours, units, etc.
34
A depreciable asset cost $24,000. Its estimated
residual value is $2,000 and its expected to have an estimated life of 10,000
operating hours.
Hourly depreciation =$24,000 – $2,00010,000 estimated hours
Hourly depreciation =
$2.20 hourly depreciation
Hourly depreciation =
Cost – estimated residual valueEstimated hours
35
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.
36
Equipment acquired at a cost of $180,000 has an estimated residual value of $10,000, an estimated useful life of 40,000 hours, and was operated 3,600 hours during the year. Determine the (a) depreciable cost, (b) depreciation rate, and (c) the units-of-production depreciation for the year.
(a) $170,000 ($180,000 – $10,000)(b) $4.25 per hour ($170,000/40,000
hours)(c) $15,300 (3,600 hours x $4.25)
37
Double-Declining-Balance Method
The double-declining-balance method provides for a declining periodic
expense over the estimated useful life
of the asset.
38
A double-declining balance rate is determined by
doubling the straight-line rate. A shortcut to
determining the straight-line rate is to divide one by the
number of years (1/5 = .20). Hence, using the double-
declining- balance method, a five-year life results in a 40
percent rate (.20 x 2).
39
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. Continuing with the
example where the fixed asset cost $24,000 and has
an expected residual value of $2,000, a table can be built.
40
$24,000 x .40
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End1$24,000 40%$9,600
41
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
$14,400 x .40
42
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,640
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
43
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,184
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
44
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,110
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
45
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,1105 3,110 40% 1,244 22,134 1,866
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
STOPDEPRECIATION STOPS WHEN
BOOK VALUE EQUALS RESIDUAL VALUE!
46
1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,1105 3,110 – $2,0001,110 22,000 2,000
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Desired ending book value
“Forced” annual depreciation
47
Equipment that was acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (a) depreciable cost, (b) double-declining-balance rate, and (c)
double-declining balance depreciation for the first year.(a) $120,000 ($125,000 – $5,000)
(b) 20% [(1/10) x2](c) $25,000 ($125,000 x 20%)
48
Comparing Depreciation Methods
49
Comparing Depreciation Methods
50
Depreciation for Federal Income Tax
The Internal Revenue Code specifies the Modified
Accelerated Cost Recovery System
(MACRS) for use by businesses in computing
depreciation for tax purposes.
51
MACRS specifies eight classes of useful life and
depreciation rates for each class. The two most
common classes are the 5-year class (includes
automobiles and light duty trucks) and the 7-year class (includes most machinery
and equipment).
52
A machine purchased for $140,000 was originally estimated to have a useful life of five years and a residual value of $10,000.
The asset has been depreciated for two years using the straight-line method.
Revising Depreciation Estimates
$140,000 – $10,000
5 years
Annual Depreciation (S/L)
=
$26,000 per yearAnnual Depreciation (S/L)
=
53
At the end of two years, the asset’s book value is $88,000, determined as
follows:
Asset cost $140,000Less accumulated depreciation
($26,000 per year x 2 years) 52,000 Book value, end of second year$
88,000
54
During the third year, the company estimates that the remaining useful life is eight years (instead of three) and that the
residual value is $8,000 (instead of $10,000). Depreciation expense for each of the remaining eight year is determined as
follows: Book value, end of second year $88,000Less revised estimated residual value 8,000Revised remaining depreciation cost$80,000
Revised annual depreciation expense($80,000 ÷ 8 years)
$10,000
55
A warehouse with a cost of $500,000 has an estimated residual value of $120,000, an estimated useful life of 40 years, and is
depreciated by the straight-line method. (a) Determine the amount of annual
depreciation. (b) Determine the book value at the end of the 20th year of use. (c) If at
the start of the 21st year it is estimated that the remaining life is 25 years and that the residual value is $150,000, determine the
depreciation expense for each of the remaining 25 years.
56
a. $9,500 [($500,000 – $120,000)/40]
b. $310,000 [$500,000 – ($9,500 x 20)]
c. $6,400 [310,000 – $150,000)/25]
57
Journalize entries for the
disposal of fixed assets.
Objective 3
Objective 3
58
Discarding Fixed Assets
A piece of equipment acquired at a cost of $25,000 is fully depreciation. On
February 14, the equipment is discarded.
Feb.14 Accumulated Depr.—Equipment25 000 00
Equipment 25 000 00To write off equipment
discarded.
59
Equipment costing $6,000 is depreciated 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 150 00 Accum. Depr.—Equipment 150 00
To record current
depreciation on
equipment
discarded.
$600 x 3/12$600 x 3/12
60
The discarding of the equipment is then recorded by the following
entry:
Mar.24 Accum. Depreciation—Equipment 4 900 00Loss on Disposal of Fixed Assets 1 100 00
Equipment 6 000 00
To write off equipment discarded.
61
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 and
needs to be updated.
Selling Fixed Assets
Oct.12 Depreciation Expense—Equipment 750 00
Accum. Depr.—Equipment 750 00To record current
depreciation on equipment sold.
$10,000 x ¾ x10%
$10,000 x ¾ x10%
62
The equipment is sold on October 12 for $2,250. No gain or loss.
Oct.12 Cash 2 250 00Accum. Depreciation—Equipment 7 750 00
Equipment 10 000 00
Sold equipment at book value.
Assumption 1
63
Oct.12 Cash 1 000 00Accum. Depreciation—Equipment 7 750 00Loss on Disposal of Fixed Assets1 250 00
Equipment 10 000 00
Sold equipment at a loss.
The equipment is sold on October 12 for $1,000; a loss of $1,250.
Assumption 2
64
Oct.12 Cash 2 800 00Accum. Depreciation—Equipment 7 750 00
Equipment 10 000 00
Sold equipment at a gain.
The equipment is sold on October 12 for $2,800; a gain of $550.
Gain on Disp. of Fixed Assets 550 00
Assumption 3
65
Equipment was acquired at the beginning of year at a cost of $91,000. The equipment was depreciated using the straight-line method based upon an estimated useful life of 9 years and an estimated residual value of $10,000.
a. What was the depreciation for the first year?
b. Assuming the equipment was sold at the end of the second year for $78,000, determine the gain or loss on sale of the equipment.
c. Journalize the entry to record the sale.
66
a. $9,000 [($91,000 – $10,000)/9]
b. $5,000 gain; $78,000 – [$91,000 – ($9,000 x 2)]
c. Cash 78,000Accum. Depreciation—Equipment 18,000
Equipment 91,000Gain on Disposal of Fixed Assets
5,000
67
Exchanging Fixed Assets
When old equipment is traded for new equipment, the seller often
allows the buyer a trade-in allowance for the old equipment traded. The remainder, the boot, is either paid in cash or recorded
as a liability.
68
Gains on exchanges of similar fixed assets are
not recognized for financial reporting
purposes.
IMPORTANT!
69
On June 19, assume that new equipment being purchased has a list price of $5,000.
The dealer allows a trade-in allowance of $1,100 on the old, similar equipment. The old equipment cost $4,000
and has a book value of $800.
70
Two Methods of Determining Cost
Method One
List price of new equipment $5,000
Trade-in allowance $1,100Book value of old equipment 800Unrecognized gain on exchange (300)Cost of new equipment $4,700
71
Method Two
Book value of old equipment $ 800Cash paid at date of exchange 3,900Cost of new equipment $4,700
Note that either method provides the same cost for the new equipment.
72
On June 19, equipment was exchanged at a gain of $300.
June19 Accum. Depreciation—Equipment 3 200 00
Equipment (old equipment) 4 000 00
To record exchange of equipment.
Cash 3 900 00
Equipment (new equipment) 4 700 00
73
Losses on Exchanges
For financial reporting purposes, losses are recognized on
exchange of similar fixed assets if the trade-in allowance is less than
the book value of the old equipment. On September 7, new
equipment was acquired by trading in old equipment with a
cost of $7,000 and a book value of $2,400, and giving a cash
payment of $8,000.
74
Cost of old equipment $7,000Accumulated depreciation at date of exchange 4,600Book value at September 7, date of exchange $2,400Trade-in allowance on old equipment 2,000Loss on exchange $ 400
Sept7 Accum. Depreciation—Equipment4 600 00Equipment 10 000 00Loss on Disposal of Fixed Assets 400 00
Equipment 7 000 00Cash 8 000 00
To record exchange of equipment with loss.
75
On the first day of the fiscal year, a delivery truck with a list price of $75,000 was acquired in exchange for an old delivery truck and $63,000 cash. The old truck had a cost of $50,000 and accumulated depreciation of $39,500.
a. Determine the cost of the new truck for financial reporting purposes.
b. Journalize the entry to record the exchange.
76
a. $73,500
List price of new truck $75,000 Trade-in allowance on old truck
($75,000 – $63,000) $12,000Book value of old truck
($50,000 – $39,500) 10,500
Unrecognized gain on exchange 1,500)
Cost of new truck $73,500
(Continued)
or
77
Book value of old truck ($50,000 – $39,5000) $10,500
Plus cash paid at date of exchange 63,000
Cost of new truck $73,500b. Truck (new) 73,500
Accum Dep Truck (old) 39,500Truck (old) 50,000
Cash 63,000
78
Compute depletion and journalize the
entry for depletion.
Objective 4
Objective 4
79
The process of transferring the cost of natural resources to an
expense account is called depletion.
Natural Resources
80
Recording 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).
81
Dec. 31 Depletion Expense 36 000 00Accumulated Depletion 36 000 00
Depletion of
mineral deposit.
Adjusting Entry
If 90,000 tons are mined during the year, an adjusting entry is required at the end of the accounting period.
82
Earth’s Treasures Mining Co. acquired mineral rights for $45,000,000. The mineral deposit is estimated at 50,000,000 tons. During the current year, 12,600,000 tons were mined and sold.
a. Determine the depletion rate.b. Determine the amount of depletion
expense for the current year.c. Journalize the adjusting entry on
December 31 to recognize the depletion expense.
83
a. $0.90 per ton = $45,000,000/50,000,000 tons
b. $11,340,000 – (12,600,000 tons x $0.90 per ton)
c. Dec. 31 Depletion Expense11,340,000Accumulated
Depletion11,340,000
Depletion of mineral deposit.
84
Describe the accounting for
intangible assets, such patents,
copyrights, and goodwill.
Objective 5
Objective 5
85
Intangible Assets
Patents, copyrights, trademarks, and goodwill are
long-lived assets that are useful in the operations of a
business and not held for sale. These assets are called intangible assets because they do not exist physically.
86
The exclusive right granted by the federal
government to manufacturers to produce and sell goods with one or more unique features is a
patent. These rights continue in effect for 20
years.
87
At the beginning of its fiscal year, a business acquires a patent right for
$100,000. Its remaining useful life is estimated at 5 years.
Journalizing Amortization of a Patent
Dec. 31 Amortization Expense—Patents20 000 00Patents 20 000 00
Patent
amortization
($100,000/5).
Adjusting Entry
88
Dec. 31 Amortization Expense—Patents20 000 00Patents 20 000 00
Patent
amortization
($100,000/5).
Adjusting Entry
Because a patent (and other intangible assets) does not exist physically, it is acceptable to
credit the asset. This approach is different from physical fixed assets that require the use of a
contra asset account.
89
The exclusive right granted by the federal government to
publish and sell a literary, artistic, or musical
composition is a copyright. A copyright extends for 70 years beyond the author’s
death.
Copyright
90
A trademark is a unique name, term, or symbol used to identify
a business and its products. Most businesses identify their
trademarks with ® in their advertisements and on their
products. Trademarks can be registered for 10 years and can
be renewed every 10 year period thereafter.
Trademark
91
In business, goodwill refers to an intangible asset of a business that is created
from such favorable factors as location, product quality, reputation, and managerial
skill.
10-5
Goodwill
92
Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a
transaction.
93
Impaired Goodwill
A loss should be recorded if the business prospects of the acquired firm (and the acquired goodwill) become significantly
impaired.
Mar. 19 Loss from Impaired Goodwill50 000 00Goodwill 50 000 00
Impaired
goodwill.
94
On December 31 it was estimated that goodwill of $40,000 was impaired. In
addition, a patent with an estimated useful economic life of 12 years was acquired for
$484,000 on July 1.a. Journalize the adjusting entry on
December 31, for the impaired goodwill.
b. Journalize the adjusting entry on December 31 for the amortization of the patent rights.
95
a.Dec. 31 Loss from Impaired Goodwill40,000Goodwill 40,000
Impaired goodwill.
b.Dec. 31 Amortization Expense—Patents3,500Patents 3,500
Amortized patent rights[($84,000/12) x (6/12)].
96
Describe how depreciation expense
is reported in an income statement, and
prepare a balance sheet that includes
fixed assets and intangible assets.
Objective 6
Objective 6
97
The fixed assets may be shown at their net amount.
The amount of each major class of fixed assets should be disclosed in the balance sheet or in notes.
Office equipment $125,750Less accumulated depreciation 86,300 Net book value $ 39,450
98
The cost of mineral rights or ore deposits is normally shown as part of the fixed asset section of the balance sheet. The related accumulated depletion should also be disclosed.
Intangible assets are usually reported (net of amortization) in the balance sheet in a separate section immediately following fixed assets.
99
Fixed Assets and Intangible Assets in the Balance Sheet
100
Fixed Asset Turnover Ratio
One measure of the revenue-generating efficiency of fixed assets is the fixed asset turnover ratio. It measures the number of dollars of revenue earned per dollar of fixed assets and is computed as follows:
Fixed Asset Turnover Ratio
Revenue
Average Book Value of Fixed Assets
=
101
Financial Analysis and Interpretation
For Marriott International, Inc. (in millions)
Fixed Asset Turnover Ratio
Revenue
Average Book Value of Fixed Assets
=
Fixed Asset Turnover Ratio
$11,550
($2,341 + 2,389)/2 =
Fixed Asset Turnover Ratio
= 4.88
Conclusion: For every dollar of fixed assets, Marriott earns $4.88 of revenue.
Summary
Classification of Fixed Assets
Depreciation Methods
Journalize related entries
Depletion
Intangibles
Financial Statement
presentation
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