Chapter 17 1 Property and Equipment and Intangible Assets College Accounting 10 th Edition Mc. Quaig Bille Nobles Power. Point presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University 17– 1 © 2011 Cengage Learning
Initial Costs of Property and Equipment § The original cost of property and equipment includes all normal expenditures necessary to acquire, install, and prepare the property and equipment for its intended use. § Expenditures that result from carelessness, vandalism, and other abnormal causes are not included in the asset’s cost. Such costs should be charged as an expense. 17– 2
Initial Costs of Property and Equipment Ham’s Burgers pays for a refrigerator in cash. The necessary journal entry, in general journal form, is shown below. 17– 3
Land § Land is the property that is used in the operations of a business. § The cost of land includes the amount paid for the land plus incidental charges connected with the purchase: • • Real estate agents’ commissions paid by the buyer Surveying, clearing, draining, or grading the land Municipal and county assessment charges Razing cost of old buildings on land 17– 4
Land Improvements § Land improvements– 1) have a determinable or finite useful life or 2) are not directly associated with a building. § Land improvements are recorded in an account by the same title (Land Improvements), thus they are not recorded in the Land account. 17– 5
Buildings § Buildings is an asset account that includes such items as warehouses, offices, and retail stores. If a building is constructed, the cost of each building includes such items as: § Labor and materials § Architectural and engineering fees § Insurance premiums during construction § Interest on loans during the period of construction 17– 6
Leasehold Improvements § Improvements made to rental property are recorded as leasehold improvements. § The Leasehold Improvements account is an asset used to record improvements in rented property that are made or paid for by the lessee but become the property of the lessor at the end of the lease term. 17– 7
Equipment § Equipment includes furniture, vehicles, computes, office equipment, and manufacturing machinery. § The Equipment account is a fixed asset. § The cost of equipment would include not only the purchase price but also such items as sales taxes, freight, installation, and assembly. 17– 8
Allocation of the Purchase Price Between Land Building Ham’s Burgers buys some real property, including land a building, for $1, 600, 000. The assessor valued the property for tax purposes at $1, 300, 000: $700, 000 for the land $600, 000 for the building. The allocation is based on the assessor’s valuations. 17– 9
Allocation of the Purchase Price Between Land Building STEP 1. Determine the asset percentages based on the assessed value. $700, 000 Assessed Value of Land = 53. 8% = $1, 300, 000 Total Assessed Value $700, 000 Assessed Value of Building = 46. 2% = $1, 300, 000 Total Assessed Value 17– 10
Allocation of the Purchase Price Between Land Building STEP 2. Determine the purchase price allocated to each asset by multiplying the purchase price by the asset percentages. LAND Purchase price x STEP 1 = $1, 600, 000 x 53. 8% = $860, 800 BUILDING Purchase price x STEP 1 = $1, 600, 000 x 46. 2% = $739, 200 17– 11
Allocation of the Purchase Price Between Land Building STEP 3. Record the journal entry for the purchase. 17– 12
The Nature and Recording of Depreciation § Depreciation, which when used by an accountant means the process of allocating the cost of an asset to an expense over its useful life. § Depreciation represents a systematic procedure for spreading the cost of fixed assets (other than land) over the fiscal periods in which the company receives services from such assets. 17– 13
Recording of Depreciation When Ham’s Burger bought the refrigerator for $3, 829, he estimated that it would have a life of five years, and therefore spreads this cost over the five years it is expected to help generate revenue. Ham’s Burgers depreciates the refrigerator $765. 80 per year. The necessary adjusting entry is recorded as follows: 17– 14
The Nature and Recording of Depreciation § Accumulated Depreciation is a contraasset account that is deducted from the related asset account. § Fixed assets are reported on the balance sheet at their book value (or carrying value). Book value is equal to the cost of the asset minus the accumulated depreciation. 17– 15
Depreciation Base § The depreciation base is the full depreciation of an asset. Depreciation Total Cost of Salvage Value = an Asset – or Trade-in Value Base § Salvage value (or trade-in value) is the expected value of the asset at disposal. § If the salvage value is expected to be insignificant, then a salvage value of zero is assigned to the asset. 17– 16
Useful Life § The useful life of an asset is the expected use of the asset. § The length of an asset’s useful life is affected by the amount of physical wear and tear to which it is subjected. § It’s expected length of life is also affected by technological change and innovation. 17– 17
Straight-Line Method § A business that uses the straight-line method calculates an equal amount of depreciation expense for each year of service anticipated. Depreciation Cost – Salvage Value = Useful Life (in years) per Year § The percentage rate of depreciation per year is determined by dividing the number of years of useful life into 1. 17– 18
Straight-Line Method Ham’s Burgers purchases a new 65 -lb. capacity fryer costing $10, 500 and having a useful life of five years. The estimated salvage value at the end of five years is $1, 000. $10, 500 – $1, 000 Depreciation Cost – Salvage Value = per Year Useful Life (in years) 5 = $1, 900 OR: 1 ÷ 5 = 20. 0% x ($10, 500 – $1, 000) = $1, 900 17– 19
Double-Declining-Balance Method § The double-declining-balance method is an accelerated method of depreciation that allows larger amounts of depreciation to be taken in the early years of an asset’s life. § Salvage value is not used in determining depreciation by the double-declining-balance method until the end of the depreciation schedule. 17– 20
Double-Declining-Balance Method STEP 1. Calculate the straight-line depreciation rate. Straight-Line Depreciation Rate = 1 Useful Life STEP 2. Multiply the straight-line rate by 2. STEP 1 × 2 STEP 3. Multiply the book value of the asset at the beginning of the year by double the straightline rate. Depreciation Expense per Year = Book Value at Beginning of Year × STEP 2 STEP 4. Do not depreciate below salvage value. The amount of depreciation can only reduce book value to salvage value. 17– 21
Double-Declining-Balance Method EXAMPLE: Ham’s Burgers purchases a new 65 -lb. capacity fryer for $10, 500, with a useful life of five years. The estimated salvage value at the end of five years is $1, 000. STEP 1. Compute the straight-line depreciation rate. Straight-Line Depreciation Rate = Straight-Line Depreciation Rate STEP 2. 1 5 years =. 020 x 100% = 20% Multiply the straight-line rate by 2. 0. 20 x 2 = 0. 40 OR 20% x 2 = 40% 17– 22
Double-Declining-Balance Method STEP 3. Depreciation Expense per Year = Book Value at Beginning of Year x 0. 40 (or 40%) *rounded 17– 23
Double-Declining-Balance Method STEP 4. Notice that in year 5 the depreciation expense stops at $1, 000 because ending book value cannot go below the salvage value. The amount of depreciation for year 5 is determined by subtracting the salvage value of $1, 000 from the book value of the fryer at the end of Year 4 ($1, 361). Observe carefully that the salvage (or trade-in) value is not used until the fifth year. 17– 24
Units-of-Production Method A salesperson’s car cost $24, 000 and has a useful life of 60, 000 miles. The estimated salvage value at the end of 60, 000 miles is $7, 200. The car is driven 18, 500 this year and 20, 000 miles next year. 17– 25
Units-of-Production Method STEP 1. Calculate the depreciation per unit. Depreciation per Unit = Cost – Salvage Value Estimated Units of Production $24, 000 – $7, 200 60, 000 miles $0. 28 per mile 17– 26
Units-of-Production Method STEP 2. Multiply the depreciation per unit by the number of units produced. Depreciation = Step 1 x Number of Units Expense per Year Produced Depreciation Expense = $0. 28 x 18, 500 = $5, 180 for 18, 500 Miles Depreciation Expense $0. 28 x 20, 000 = $5, 600 for 20, 000 Miles = 17– 27
Depreciation for Periods of Less Than a Year Computed from May 1 17– 28
Depreciation for Periods of Less Than a Year Computed from November 1 17– 29
Modified Accelerated Cost Recovery System (MACRS) § For property acquired after 1986, a schedule of depreciation called the Modified Accelerated Cost Recovery System (MACRS) has been established. § Under MACRS, assets are divided into classes. 17– 30
MACRS Property Classes 17– 31
Modified Accelerated Cost Recovery System (MACRS) § The following chart provides the percentage of cost allocation (written off or depreciated) each year for three-year, five-year, and seven-year property. 17– 32
Modified Accelerated Cost Recovery System (MACRS) Ham’s Burgers purchases a new fixture (classified as seven-year property) having a cost of $300. STEP 1. Determine into which of the eight classes the asset falls. The new fixture falls in the seven-year property category. STEP 2. Consult the schedule to determine the percentage figure for each year. The percentage for the first year is 14. 29%. 17– 33
Modified Accelerated Cost Recovery System (MACRS) STEP 3. Multiply the cost of the asset by the percentage figure. Depreciation Expense for Year 1 = $300 x 0. 1429 = $42. 87 Depreciation Expense for Year 2 = $300 x 0. 2449 = $73. 47 17– 34
Capital Expenditures Capital expenditures include the initial costs debited to property and equipment; they also include any costs of enlarging or increasing the capacity of assets. § Ham’s Burgers spends $20, 000 to modify an existing fast-food restaurant by enlarging it. 17– 35
Revenue Expenditures Revenue expenditures include the costs of maintaining the operation of an asset, such as the expense of making normal repairs. § Ham’s Burgers spent $350 repairing the plumbing in an existing fast-food restaurant. 17– 36
Extraordinary-Repairs Expenditures Extraordinary-repairs expenditures refer to a major overhaul or reconditioning that either extends the useful life of an asset beyond its original estimated life or increases the estimated trade-in value. Example: On January 3, Year 1, Ham’s Burgers bought a used truck for $18, 000. The truck’s estimated useful life is four years and its trade-in value is $5, 000. 17– 37
Extraordinary-Repairs Expenditures § Straight-line annual depreciation expense is $3, 100. On January 5, Year 4, Ham’s Burger puts in a new engine and has other major repairs done, for which it spends $3, 480 in cash. 17– 38
Extraordinary-Repairs Expenditures §The extraordinary repair extends the life of the truck from the present one additional year to three additional years. Truck + Jan. 3, Year 1 Jan. 5, Year 4 – 18, 000 3, 480 17– 39
Extraordinary-Repairs Expenditures § The truck’s book value before the extraordinary repair was $8, 700 ($18, 000 – $9, 300). After the extraordinary repair it is $12, 180 ($18, 000 – $3, 480 – $9, 300). 17– 40
Recalculating Depreciation New book value ($21, 480 – $9, 300) Less trade-in value (assumed the same) New depreciation base $12, 180 5, 600 $ 6, 580 Depreciation expense = $6, 580 ÷ 3 = $2, 193* *rounded The adjusting entry for depreciation of the truck at the end of Year 4 is as follows: 17– 41
Discarding or Retiring Property and Equipment Step 1. Record the entry to depreciate the asset up to date, if applicable. Step 2. Calculate the book value. Step 3. Determine the gain or loss. Step 4. Record the entry to discard or sell the asset. 17– 42
Discarding or Retiring Property and Equipment A display case that originally cost $1, 760, with a zero salvage value, and that has been fully depreciated is given away as junk. 17– 43
Discarding or Retiring Property and Equipment STEP 1. No entry is required because the asset is fully depreciated. STEP 2. Once an asset is fully depreciated, the asset’s book value remains at its estimated salvage value unless an extraordinary repair is made or the company disposes of the asset. Book Value = $1, 760 – $1, 760 = $0 17– 44
Discarding or Retiring Property and Equipment STEP 3. If an asset is fully depreciated and the company does not receive any cash for discarding the asset, there is no gain or loss recognized. STEP 4. A journal entry is made to record disposal of the display case. 17– 45
Discarding an Asset Not Fully Depreciated On August 12, Ham’s Burgers discards a printer that originally cost $1, 720. No salvage value is recognized. Accumulated Depreciation up to the end of the previous year is $1, 032. Depreciation for the current year through August 12 is $352. Accumulated Depreciation, Office Equipment – + Bal. $1, 1, 17– 46
Discarding an Asset Not Fully Depreciated STEP 1. Record the entry to depreciate the printer up to date. Accumulated Depreciation, Office Equipment – + Bal. $1, 1, 17– 47
Discarding an Asset Not Fully Depreciated STEP 2. Calculate the book value. Book Value = $1, 720 – $1, 384 = $336 STEP 3. Because the firm realized nothing from the disposal of the asset, the loss is for the same amount as the book value. Loss = $0 – $336 = $(336) 17– 48
Discarding an Asset Not Fully Depreciated STEP 4. Record the journal entry for the disposal of the printer. 17– 49
Sale of an Asset at a Loss On August 21, Ham’s Burgers sells a kitchen range for $150, which originally cost $2, 100; accumulated depreciation to the end of the previous year (December 31) was $1, 680. Yearly depreciation is $210. STEP 1. Record the entry to depreciate the kitchen range up to date. After posting the journal entry, the Accumulated Depreciation, Equipment account will have a balance of $1, 820. 17– 50
Sale of an Asset at a Loss STEP 2. Calculate the book value. Book Value = $2, 100 – $1, 820 = $280 STEP 3. Determine the gain or loss. Loss = $150 – $280 = $(130) 17– 51
Sale of an Asset at a Loss STEP 4. The entry to record the sale of the kitchen range is shown in general journal form. 17– 52
Sale of an Asset at a Gain On October 18, Ham’s Burgers sells a dishwasher for $400 for which it originally paid $4, 400; accumulated depreciation is $3, 900. Yearly depreciation is $360. STEP 1. Record the entry to depreciate the dishwasher up to date. After the above entry, Accumulated Depreciation, Equipment has a balance of $4, 260. 17– 53
Sale of an Asset at a Gain STEP 2. Calculate the book value. Book Value = $4, 400 – $4, 260 = $140 STEP 3. Determine the gain or loss. Gain = $400 – $140 = $260 17– 54
Sale of an Asset at a Gain STEP 4. The entry, in general journal form, to record the sale of the dishwasher is as follows: 17– 55
Exchange of Long-Lived Assets for Other Similar Assets § A gain on an exchange of this nature results when the market (or trade-in allowance) is greater than the book value. § A loss on an exchange of this nature results when the market (or trade-in allowance) is less than the book value. § Gains and losses are record for GAAP purposes; however, federal income tax laws require no gain or loss to be recognized. 17– 56
Exchange When Trade-In Value Is Greater Than Book Value Ham’s Burgers bought a copier for $2, 600. After some years, Ham’s Burgers decides to trade it in on a new model. The old copier has accumulated depreciation of $2, 480 on the date of the tradein, leaving a book value of $120 ($2, 600 – $2, 480). The new copier has a list price of $3, 350. Ham’s Burgers is allowed a trade in allowance of $310; the difference is paid in cash. 17– 57
Debit Office Equipment (new) for its list price. Close Accumulated Depreciation, Office Equipment for the accumulated depreciation on the old equipment. 17– 58
Remove the cost of the old office equipment from the ledger. Calculate the gain ($310 – $120) = $190 and credit the gain account. Credit Cash, $3, 040 (quoted price of the new copier $3, 350, minus the $310 trade-in allowance).
Exchange When Trade-In Value Is Less Than Book Value Ham’s Burgers bought a delivery truck for $30, 400. Four years later, the truck has accumulated depreciation of $26, 200 (book value = $30, 400 – $26, 200 = $4, 200). Ham’s Burgers buys a new truck, with a list price of $35, 400, trading in the old one, for which the company is allowed $2, 800, and paying the difference in cash. The depreciation is up to date. 17– 60
List price of new delivery truck. Accumulated Depreciation, Delivery Equipment is debited to remove accumulated 17– 61 depreciation related to old delivery truck.
The cost of the old delivery truck is removed from the ledger. The loss is determined as follows: $2, 800 – $4, 200 = $(1, 400). Credit Cash, $32, 600 (quoted price of the new truck , $35, 400, minus the $2, 800 trade-in allowance). 17– 62
Property and Equipment Records § Subsidiary ledgers can be used when recording property and equipment. For example, the Store Equipment account represents a functional group; it includes all types of equipment used in a store. § When using subsidiary ledgers, Store Equipment is a controlling account; the property and equipment ledger is a subsidiary ledger. 17– 63
Property and Equipment Records 17– 64
Intangible Assets Intangible assets are assets that are purchased for use in the business and have a useful life longer than one year but have no physical substance. § A patent is an exclusive right to sell or produce an invention. § A copyright is an exclusive right of protection to creators of artistic works. § A trademark represents a word, slogan, or symbol that identifies a company or product. § A franchise is an exclusive right to use a company’s name and to sell its products. § Goodwill represents the value of the business over its identified assets. It must be determined by the purchase price. 17– 65
Intangible Assets On January 1, Ham’s Burgers purchases a patent costing $20, 000 with a useful life of 10 years. Ham’s Burgers pays for the patent in cash On December 31, the following entry would be made: 17– 66
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