2. Costs of Acquiring Fixed Assets
Building
• Architects’ Fees
• Engineers’ Fees
• Insurance costs incurred during
construction
• Interest on amount borrowed
to finance construction
• Walkways to and around the
building
• Sales taxes
• Repair (purchase of existing
building)
• Reconditioning (purchase of
existing building)
• Modifying for use
• Permits from government
agencies
Machinery and Equipment
• Sales taxes
• Freight
• Installation
• Repairs (purchase of
used equipment)
• Reconditioning
(purchase of used
equipment)
• Insurance while in
transit
• Assembly
• Modifying for use
• Testing for use
• Permits from
government agencies
Land
• Purchase price
• Sales taxes
• Permits from
government agencies
• Broker’s commissions
• Title fees
• Surveying fees
• Delinquent real estate
taxes
• Removing unwanted
building less any
salvage
• Grading and leveling
• Paving a public street
bordering the land
Land Improvements
• Trees and streets
• Fences
• Outdoor lighting
• Paved parking areas
3. Capital and Revenue Expenditure
Once an asset is acquired and placed in service, costs may be incurred for ordinary maintenance
and repairs.
Costs may be incurred for improving an asset or for extraordinary repairs that extend the asset’s
useful life.
Costs that benefit only the current period are called revenue expenditure.
Costs that improve the asset or extend its useful life are capital expenditure.
4. Capital and Revenue Expenditure
Ordinary Maintenance and Repairs: Costs related to the ordinary maintenance and repairs of a fixed asset are
recorded as an expense of the current period.
Asset Improvements: After a fixed asset has been placed in service, cost may be incurred to improve the asset.
Such costs are capital expenditures and are recorded as increase to the fixed asset account. Because the cost of
the delivery truck has increased, depreciation for the truck would also change over its remaining useful life.
Extraordinary Repairs: After a fixed asset has been placed in service, costs may be incurred to extend its useful life.
Such costs are capital expenditure and are recorded as a decrease in an accumulated depreciation account.
Because the useful life has changed, depreciation would also change based on the new book value of the asset.
Repairs and Maintenance Expense
Cash
300
300
Delivery Truck
Cash
5,500
5,500
Accumulated Depreciation - Asset
Cash
4,500
4,500
5. Accounting for Revenue and Capital Expenditure
Cost
Benefits only
current
period
REENUE
EXPENDITURE
Ordinary
Repairs and
Maintenance
Debit Repairs
and
Maintenance
Expenditure
Benefits
current and
future
periods
CAPITAL
EXPENDITURE
Asset
Improvement
Adds service
value to the
asset
Debit Fixed
Asset
Extraordinary
Repair
Extends the
asset’s useful
life
Debit
Accumulated
Depreciation
Revise
depreciation
for current
and future
periods
6. Leasing Fixed Assets
A lease is a contract for the use of an asset for a specific period of time.
Automobiles, Computers, Medical Equipment, Buildings and Airplanes are often leased.
Two parties to a lease contract are as follows:
◦ The lessor is the party who owns the asset.
◦ The lessee is the party to whom the rights to use the assets are granted by the lessor.
Under the lease contract, the lessee pays rent on a periodic basis for the lease term.
The lessee accounts for a lease contract in one or two ways depending on how the lease
contract is classified.
7. Leasing Fixed Assets
A lease contract can be classified as either a:
◦ Capital lease
◦ Operating lease
Capital lease is accounted for as if the lessee has purchased the asset. The lessee debits an
asset account for the fair market value of the asset and credits a long-term lease liability
account. Then asset is then written off as an expense over the life of the capital lease.
Operating lease is accounted for as if the lessee is renting the asset for the lease term. The
lessee records operating lease payments by debiting Rent Expense and crediting cash. The
lessee’s future lease obligations are not recorded in the accounts.
8. Accounting for Depreciation
Fixed asset lose their ability over time to provide services.
Therefore, cost of fixed assets such as equipment and buildings should be recorded as an
expense over their useful lives.
This periodic recording of the cost of fixed assets as an expense is called depreciation.
As land has unlimited life, it is not depreciated.
The adjusting entry to record depreciation:
Month Day Depreciation Expense
Accumulated Depreciation/Allowance for Depreciation
XXX
XXX
9. Depreciation Factors
Depreciation can be caused by physical or functional factors.
Physical depreciation factors include wear and tear during use or exposure to weather.
Functional depreciation factors include obsolescence and changes in customer needs that cause
the asset to no longer provide service for which it was intended.
10. Misunderstandings
Depreciation does not measure the decline in the market value of a fixed asset.
Depreciation does not provide cash to replace fixed assets as they wear out.
11. Factors in Computing Depreciation
Expense
Three factors determine the depreciation expense for a fixed asset.
◦ Asset’s initial cost.
◦ Asset’s expected useful life – estimated at the time the asset is placed into service.
◦ Asset’s estimated residual value (scrap value, salvage value or trade-in value).
Residual value of a fixed asset at the end of its useful life is estimated at the time the asset is placed
into service.
Initial Cost - Residual Value = Depreciable
Cost
Year 1 Year 2 Year 3 Year 4 Year 5
12. Common Depreciation Methods
Straight-Line Depreciation – Same amount of depreciation for each year of assets useful life. It is
the most widely used method.
Units-of-Production Depreciation – Provides same amount of depreciation for each unit of
production. Depending on the asset, the units of production can be expressed in terms of hours,
miles driven or quantity produced.
Double-Declining-Balance Depreciation – Provides for a declining periodic expense over the
expected life of the asset.
13. Straight-Line Depreciation
Annual Depreciation = (Cost – Residual Value) / Useful Life
If an asset is used for only part of a year, the annual deprecation is prorated. If asset is purchased on 1st
October, depreciation for remaining year will be
First Year Partial Depreciation = $4,400 * 3 / 12 = $1,100.
Straight Line Depreciation may be converted to a percentage of depreciable cost:
Expected Years of Useful Life Straight-Line Percentage
5 Years 20% (100% / 5)
8 Years 12.5% (100% / 8)
10 Years 10% (100% / 10)
Cost of Asset 24,000.00 Residual Value 2,000.00 Useful Life 5 years
Depreciation
Cost of Asset - Residual Value
Useful Life
$24,000 - $2,000
5 Years
4,400.00
$ Per Year
14. Units-of-Production Depreciation
It is applied in two steps.
Step 1: Determine the depreciation per unit as:
Depreciation per units = (Cost – Residual Value) / Total Units of Production
Step 2: Compute the depreciation expense as:
Depreciation Expense = Depreciation per unit * Total Units of Production Used
Cost of Asset 24,000.00 Residual Value 2,000.00 Useful Life 5 years
Operational
Time
2,100
Hours
Step 1
Depreciation
per hour
Cost of Asset - Residual Value
Total Unit of Poduction
$24,000 - $2,000
10,000 Hours
2.20
$ Per Hour
Step 2
Depreciation
Expence
Depreciation per Unit * Total
Unit of Production Used
$2.20 per unit *
2,100 Hours
4,620.00
$
15. Double-Declining-Balance Depreciation
It is applied in three steps:
Step 1. Determine the straight-line percentage using the expected useful life.
Step 2. Determine the double-declining-balance rate by multiplying the straight-line rate from
step 1 by two.
Step 3. Compute the depreciation expense by multiplying the double-declining-balance rate from
step2 times the book value of the asset.
Cost of Asset 24,000.00 Residual Value 2,000.00 Useful Life 5 years
Operational
Time
Step 1 Straight-line percentage (100% * 5) 20%
Step 2 Double-declining-balance rate (20% * 2) 40%
Step 3 Depreciation expense ($24,000 * 40%) 9,600
16. Double-Declining-Balance Depreciation
When double-declining-balance method is used, the estimated residual value is not considered. But, the asset should not
be depreciated below its estimated residual value. Therefore the depreciation for the 5th year is $1,110.40 ($3,110.40 –
$2,000,00) instead of $1,244.16 (40% * $3,110.40).
The double-declining-balance method provides a higher depreciation in the first year of the assets use, followed by
declining depreciation amounts. For this reason, it is also called accelerated depreciation method.
A company may use Straight line method for financial statements and accelerated method for tax purposes.
Year Cost
Acc. Dep. At
Beginning of Year
Book Value at
Beginning of Year
Double
Declining Bal.
Rate
Depreciation
for Year
Book Value at
End of Year
1 $24,000 $ 24,000.00 40% $ 9,600.00 $ 14,400.00
2 24,000 $ 9,600.00 14,400.00 40% 5,760.00 8,640.00
3 24,000 15,360.00 8,640.00 40% 3,456.00 5,184.00
4 24,000 18,816.00 5,184.00 40% 2,073.60 3,110.40
5 24,000 20,889.60 3,110.40 40% 1,110.40 2,000.00
17. Comparing Depreciation Methods
Method Useful Life Depreciable Cost Depreciation Rate
Depreciation
Expense
Straight-line Years Cost less Residual Value Straight-line rate Constant
Units-of-
production
Total units of
production
Cost less Residual Value
(Cost – Residual value) /
Total units of production
Variable
Double-declining-
balance
Years
Declining book value, but
not below residual value
Straight-line rate * 2 Declining
19. Disposal of Fixed Assets
Fixed assets that are no longer useful may be discarded or sold.
In such cases, the fixed asset is removed from the accounts.
Just because a fixed asset is fully depreciated does not mean that it should be removed from
accounts.
If a fixed asset is still being used, its cost and accumulated depreciation should remain in the
ledger even if the asset is fully depreciated.
If the asset is removed from ledger, there will be no evidence of the continuity of the asset in
the accounts.
Furthermore, cost and accumulated depreciation data on such assets are often needed for
property tax and income tax reports.
20. Discarding Fixed Assets
If a fixed asset is no longer used and has no residual value, it is discarded.
If an asset has not been fully depreciated, depreciation should be recorded before removing the
asset from the accounting record.
Feb 14 Accumulated Depreciation – Equipment
Equipment
To write off equipment discarded
25,000
25,000
Mar 24 Depreciation Expense 150
Accumulated Depreciation - Equipment 150
To record current depreciation of the
asset discarded ($600 * 3/12)+D25
Mar 24 Accumulated Depreciation - Equipment 4,900
Loss on Disposal of Equipment 1,100
Equipment 6,000
To write off equipment discarded
21. Selling Fixed Asset
The entry to record the sale of a fixed asset is similar to the entries for
discarding an asset. The only difference is that the receipt of cash is also
recorded.
If selling price is more than the book value, a gain is recorded and if it s less than
the book, a loss is recorded.
