10 Fixed Assets and Intangible Assets Principles of Financial Accounting, 11 e Reeve • Warren • Duchac
Fixed Learning Objective 1 Assets and Intangible Assets 3 -1 After studying this chapter, you should be able to: 1 Define, classify, and account for the cost Insert Chapter Objectives of fixed assets. Describe the naturethe 2 Compute depreciation, using of following methods: straight-line method, adjusting method, and units-of-production process. doubledeclining-balance method. 3 10 -2 Journalize entries for the disposal of fixed assets.
Fixed Assets and Intangible Assets (continued) 4 5 Describe the accounting for intangible assets, such as patents, copyrights, and goodwill. 6 10 -3 Compute depletion and journalize the entry for depletion. Describe how depreciation expense is reported in an income statement and prepare a balance sheet that includes fixed assets and intangible assets.
1 Describe, classify, and account for the cost of fixed assets. 10 -4
1 Nature of Fixed Assets Fixed assets are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for fixed assets are plant and equipment. 10 -5
1 Fixed assets have the following characteristics: 1. They exist physically and, thus, are tangible assets. 2. They are owned and used by the company in its normal operations. 3. They are not offered for sale as part of normal operations. 10 -6
1 Exhibit 2 10 -7 Classifying Costs
1 Exhibit 3 10 -8 Costs of Acquiring Fixed Assets (continued)
1 Exhibit 3 10 -9 Costs of Acquiring Fixed Assets (continued)
1 Exhibit 3 10 -10 Costs of Acquiring Fixed Assets (continued)
1 Exhibit 3 10 -11 Costs of Acquiring Fixed Assets (continued)
1 Cost of Acquiring Fixed Assets Excludes: 1. 2. 3. 4. Vandalism Mistakes in installation Uninsured theft Damage during unpacking and installing 5. Fines for not obtaining proper permits from government agencies These costs are expenses. 10 -12
1 Capital and Revenue Expenditures • Expenditures that benefit only the • 10 -13 current period are called revenue expenditures. Expenditures that improve the asset or extend its useful life are capital expenditures.
1 REVENUE EXPENDITURES Normal and ordinary repairs and maintenance 10 -14 CAPITAL EXPENDITURES Additions, improvements, and extraordinary repairs
1 Ordinary Maintenance and Repairs On April 9, the firm paid $300 for a tune-up of a delivery truck. This is a revenue expenditure. 10 -15
1 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. This is a capital expenditure. 10 -16
1 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 October 14. This is a capital expenditure. 10 -17
1 Capital and Revenue Expenditures 10 -18
1 Example Exercise 10 -1 Capital and Revenue Expenditures 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. Follow My Example 10 -1 June 18 Delivery Truck…………………. . . . 1, 200 Cash………………. . . 1, 200 Follow My Example 6 -1 18 Repairs and Maintenance Exp…… Cash……………. . 45 45 For Practice: PE 10 -1 A, PE 10 -1 B 10 -20 10 -19
1 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. 10 -20
1 Leasing Fixed Assets A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease (an operating lease is treated as an expense). 10 -21
2 Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining balance method. 10 -22 10 -23
2 Depreciation Over time, fixed assets such as equipment, buildings, and land improvements lose their ability to provide services. The periodic recording of the cost of fixed assets to expense is called depreciation. 10 -23
2 1. Physical depreciation factors include wear and tear during use or from exposure to the weather. 2. Functional depreciation factors include obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended. 10 -24
2 • Depreciation does not measure a • 10 -25 decline in the market value of a fixed asset. Depreciation does not provide cash to replace fixed assets as they wear out.
2 Factors in Computing Depreciation 1. The asset’s initial cost. 2. The asset’s expected useful life. 3. The asset’s estimated residual value. 10 -26
2 Residual Value The expected useful life of a fixed asset is estimated at the time the asset is placed into service. The residual value of a fixed asset at the end of its useful life is estimated at the time the asset is placed into service. 10 -27
2 Exhibit 4 10 -28 Depreciation Expense Factors
2 Exhibit 5 10 -29 Use of Depreciation Methods
2 Straight-Line Method The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life. Cost – estimated residual value Annual = Estimated life depreciation 10 -30
2 A depreciable asset cost $24, 000. Its estimated residual value is $2, 000 and its estimated useful life is five years. Cost – estimated residual value Annual = Estimated life depreciation Annual = depreciation $24, 000 – $2, 000 5 years expected useful life Annual = $4, 400 depreciation 10 -31
2 If the preceding equipment was purchased and placed into service on October 1, the depreciation would be $1, 100, computed as follows: $4, 400 × 3/12 = $1, 100 10 -32
2 Example Exercise 10 -2 Straight-Line Depreciation Equipment 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. Follow My Example 10 -2 a. $120, 000 ($125, 000 – $5, 000) b. My = 1/10 Follow 10% Example 6 -1 c. $12, 000 ($120, 000 × 10%) or ($120, 000 ÷ 10 years) 10 -34 10 -33 For Practice: PE 10 -2 A, PE 10 -2 B
2 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. Depreciati on per unit = 10 -34 Cost – Residual Value Total Units of Production
2 A depreciable asset cost $24, 000. Its estimated residual value is $2, 000 and it is expected to have an estimated life of 10, 000 operating hours. Depreciati on per unit = Depreciati on per unit Cost – Residual Value Total units of production $24, 000 – $2, 000 = Depreciati 10, 000 hours expected useful on per unit 10 -35 life = $2. 20 per hour
2 A depreciable asset cost $24, 000. Its estimated residual value is $2, 000 and it is expected to have an estimated life of 10, 000 operating hours. During the year the asset was operated 2, 100 hours. Depreciation per Unit × Total on = Units of Production Used Depreciati ($2. 20 per hour) × (2, 100 on = Depreciation = $4, 620 10 -36 hours)
2 Example Exercise 10 -3 10 -2 Units-of-Production Depreciation 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-ofproduction depreciation for the year. Follow My Example 10 -3 a. $170, 000 ($180, 000 – $10, 000) b. $4. 25 per hour ($170, 000 ÷ 40, 000 hours) c. $15, 300 (3, 600 hours × $4. 25) 10 -38 10 -37 For Practice: PE 10 -3 A, PE 10 -3 B
2 Double-Declining-Balance Method The double-declining-balance method provides for a declining periodic expense over the estimated useful life of the asset. 10 -38
2 A double-declining balance rate is determined by doubling the straightline 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-decliningbalance method, a five-year life results in a 40 percent rate (. 20 × 2). (continued) 10 -39
2 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. 10 -40
2 Book Value Beginning Year of Year 1 $24, 000 Rate 40% Annual Deprec. Accum. Deprec. Year-End $9, 600 $24, 000 ×. 40 10 -41 Book Value Year-End
2 Book Value Beginning Year of Year 1 2 $24, 000 14, 400 Rate 40% Annual Deprec. $9, 600 5, 760 Accum. Deprec. Year-End Book Value Year-End $9, 600 $14, 400 ×. 40 10 -42
2 Book Value Beginning Year of Year 1 2 10 -43 $24, 000 14, 400 Rate 40% Annual Deprec. Accum. Deprec. Year-End Book Value Year-End $9, 600 5, 760 $9, 600 15, 360 $14, 400 8, 640
2 Book Value Beginning Year of Year 1 2 3 10 -44 $24, 000 14, 400 8, 640 Rate 40% 40% Annual Deprec. Accum. Deprec. Year-End Book Value Year-End $9, 600 5, 760 3, 456 $9, 600 15, 360 18, 816 $14, 400 8, 640 5, 184
2 Book Value Beginning Year of Year 1 2 3 4 10 -45 $24, 000 14, 400 8, 640 5, 184 Rate 40% 40% Annual Deprec. Accum. Deprec. Year-End Book Value Year-End $9, 600 5, 760 3, 456 2, 074 $9, 600 15, 360 18, 816 20, 890 $14, 400 8, 640 5, 184 3, 110
2 Book Value Beginning Year of Year 1 2 3 4 5 $24, 000 14, 400 8, 640 5, 184 3, 110 Rate 40% 40% 40% Annual Deprec. Accum. Deprec. Year-End Book Value Year-End $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 DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE! 10 -46 STOP
2 Book Value Beginning Year of Year 1 2 3 4 5 Rate $24, 000 40% 14, 400 40% 8, 640 40% 5, 184 40% 3, 110 – $2, 000 Annual Deprec. Accum. Deprec. Year-End Book Value Year-End $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 “Forced” annual depreciation 10 -47 Desired ending book value
2 If the preceding equipment was purchased and placed into service on October 1, depreciation for the year ending December 31 would be $2, 400, computed as follows: $9, 600 × 3/12 = $2, 400 10 -48
2 The depreciation for the second year would then be $8, 640, computed as follows: $8, 640 = [40% × ($24, 000 – $2, 400)] 10 -49
2 Example Exercise 10 -4 Double-Declining-Balance Depreciation Equipment 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 (b) double-declining-balance rate, and (c) double-declining balance depreciation for the first year. Follow My Example 10 -4 a. 20% [(1/10) × 2] b. $25, 000 ($125, 000 × 20%) 10 -51 10 -50 For Practice: PE 10 -4 A, PE 10 -4 B
3 Journalize entries for the disposal of fixed assets. 10 -51 10 -63
3 Discarding Fixed Assets A piece of equipment acquired at a cost of $25, 000 is fully depreciation at December 31, 2009. On February 14, 2010, the equipment is discarded. 10 -52
3 Equipment costing $6, 000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2009, adjusting entry, Accumulated Depreciation—Equipment has a $4, 750 balance. On March 24, 2010, the asset is removed from service and discarded. $600 × 3/12 10 -53
3 The discarding of the equipment is then recorded as follows (note that this is the second of two entries on March 24): 10 -54
3 Selling Fixed Assets Equipment was purchased at a cost of $10, 000. It had no estimated residual value and was depreciated at a straight-line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7, 000. 10 -55
3 The entry to update the depreciation for the nine months of the current year is as follows: 10 -56
3 Assumption 1 The equipment is sold on October 12 for $2, 250. No gain or loss. 10 -57
3 Assumption 2 The equipment is sold on October 12 for $1, 000; a loss of $1, 250. 10 -58
3 Assumption 3 The equipment is sold on October 12 for $2, 800; a gain of $550. 10 -59
3 Example Exercise 10 -6 Sale of Equipment was acquired at the beginning of the 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. 10 -72 10 -60
3 Example Exercise 10 -6 (continued) Follow My Example 10 -6 a. $9, 000 [($91, 000 – $10, 000) ÷ 9] b. $5, 000 gain: $78, 000 – [$91, 000 – ($9, 000 × 2)] c. Cash……………………… 78, 000 Accum. Depreciation—Equipment. . . 18, 000 Equipment………………. . 91, 000 Gain on Disposal of Fixed Assets…… 5, 000 For Practice: PE 10 -6 A, PE 10 -6 B 10 -73 10 -61
4 Compute depletion and journalize the entry for depletion. 10 -62 10 -74
4 Natural Resources The process of transferring the cost of natural resources to an expense account is called depletion. 10 -63
4 A business paid $400, 000 for the mining rights to a mineral deposit estimated at 1, 000 tons of ore. Step 1: Determine the depletion rate per ton. Depletion Cost of Resources = Rate Estimated Total Units of Resources 10 -64
4 A business paid $400, 000 for the mining rights to a mineral deposit estimated at 1, 000 tons of ore. Step 1: Determine the depletion rate per ton. $. 40 per = ton 10 -65 $400, 000 1, 000
4 A business paid $400, 000 for the mining rights to a mineral deposit estimated at 1, 000 tons of ore. Step 2: Multiply the depletion rate by the quantity extracted during period. $0. 40 per ton × $90, 000 tons = $36, 000 10 -66
4 The adjusting entry to record the depletion is shown below. 10 -67
4 Example Exercise 10 -7 Depletion Earth’s Treasures Mining Co. acquired mineral rights for $45, 000. The mineral deposit is estimated at 50, 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. 10 -80 10 -68
4 Example Exercise 10 -7 (continued) Follow My Example 10 -7 a. $0. 90 per ton = $45, 000 ÷ 50, 000 tons b. $11, 340, 000 = (12, 600, 000 tons × $0. 90 per ton) c. Depletion Expense………………. . 11, 340, 000 Accumulated Depletion. . 11, 340, 000 Depletion of mineral deposit. For Practice: PE 10 -7 A, PE 10 -7 B 10 -81 10 -69
5 Describe the accounting for intangible assets, such as patents, copyrights, and goodwill. 10 -70 10 -82
5 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. 10 -71
5 Patent 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. 10 -72
5 Amortizing a Patent 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. 10 -73
5 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. 10 -74
5 Copyright 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. 10 -75
5 Trademark 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. 10 -76
5 Goodwill 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 -77
5 Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction. 10 -78
6 Describe how depreciation expense is reported in an income statement and prepare a balance sheet that includes fixed assets and intangible assets. 10 -79 10 -96
6 10 -80
6 • Intangible assets are usually reported in the • • 10 -81 balance sheet, supported by a note with a separate listing. The balance in each class of intangible assets should be disclosed net of any amortization. The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets section of the balance sheet.
6 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: Revenue Fixed Asset = Turnover Ratio Average Book Value of Fixed Assets 10 -82
6 For Marriott International, Inc. (in millions) Fixed Asset = Turnover Ratio 10 -83 Revenue Average Book Value of Fixed Assets $12, 160 ($1, 238 + 2, 341)/2 6. 79
Appendix 2: Exchanging Similar Fixed Assets 10 -84 10 -103
(see Slide 105) 10 -85
Calculating the Gain Price (fair market value) of new equipment Less assets given up in exchange: Book value of old equipment ($4, 000 – $3, 200) Cash paid on the exchange Gain on exchange of assets 10 -86 $5, 000 $ 800 3, 900 4, 700 $ 300
Loss on Exchange of Similar Assets This time assume that only a $675 trade-in allowance was allowed towards the purchase of the new equipment. Because the market value of the new equipment is $5, 000, the cash paid on the exchange amounts to $4, 325. 10 -87
10 -88
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