ch10- Fixed Assets and Intangible Assets.ppt

Chapter 10
Fixed Assets and
Intangible Assets
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© Copyright 2004 South-Western, a division
of Thomson Learning. All rights reserved.
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1. Define fixed assets and describe the
accounting for their cost.
2. Compute depreciation, using the following
methods: straight-line method, units-of-
production method, and declining-balance
method.
3. Classify fixed asset costs as either capital
expenditures or revenue expenditures.
4. Journalize entries for the disposal of fixed
assets.
5. Define a lease and summarize the accounting
rules related to the leasing of fixed assets.
Objectives
After studying this
chapter, you should
be able to:

6. Describe internal controls over fixed assets.
7. Compute depletion and journalize the entry for
depletion.
8. Describe the accounting for intangible assets,
such as patents, copyrights, and goodwill.
9. Describe how depreciation expense is
reported in an income statement, and prepare
a balance sheet that includes fixed assets and
intangible assets.
10. Compute and interpret the ratio of fixed assets
to long-term debt.
Objectives

Nature of Fixed Assets
Fixed assets are long term or
relatively permanent assets
Fixed assets are tangible assets
because they exist physically.
They are owned and used by the
business and are not held for sale
as part of normal operations.

Classifying Costs
Is the purchased
item long-lived?
Yes
Is the asset used in
a productive
purpose?
No
Expense
Yes
Fixed Assets
No
Investment

Land
• Purchase price
• Sales taxes
• Permits from government
agencies
• Broker’s commissions
• Title fees
• Surveying fees

Land
• 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 the
salvage
• Grading and leveling
• Paving a public street
bordering the land

 Architects’ fees
 Engineers’ fees
 Insurance costs incurred
during construction
 Interest on money
borrowed to finance
construction
 Walkways to and around
the building
Buildings

Buildings
 Sales taxes
 Repairs (purchase of
existing building)
 Reconditioning
(purchase of an existing
building)
 Modifying for use
 Permits from
governmental agencies

• Trees and shrubs
• Fences
• Parking areas
• Outdoor lighting
• Concrete sewers and drainage
• Paved parking areas
Land Improvements

Machinery and Equipment
• Sales taxes
• Freight
• Installation
• Repairs (purchase
of used equipment)
• Reconditioning
(purchase of used
equipment)

Machinery and Equipment
• Insurance while in
transit
• Assembly
• Modifying for use
• Testing for use
• Permits from
governmental
agencies

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

Nature of Depreciation
All fixed assets except land lose their capacity
to provide services. This loss of productive
capacity is recognized as Depreciation Expense.
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
longer able to provide services at the level for
which it was intended, e.g., personal computer.

Depreciation Expense Factors
Initial Cost Residual Value
- = Depreciable Cost
Useful Life
Periodic Depreciation
Expense

83%
4%
8% 5%
Straight-Line
Declining-
Balance
Other Units-of-Production
Source: Accounting Trends & Techniques, 56th. ed., American Institute of
Certified Public Accountants, New York, 2002.
Use of Depreciation Methods

Facts
Original Cost.....………….. $24,000
Estimated Life in years….. 5 years
Estimated Life in hours….. 10,000
Estimated Residual Value... $2,000

Straight-Line Method
Cost – estimated residual value
Estimated life
= Annual depreciation

$24,000 – $2,000
5 years
= $4,400 annual depreciation

Straight-Line Rate
$24,000 – $2,000
5 years
= $4,400
$4,400
$24,000
= 18.3%

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.

Accum. Depr. Book Value Depr. Book Value
at Beginning at Beginning Expense at End
Year Cost of Year of Year for Year of Year
1 $24,000 $24,000 $4,400 $19,600
2 24,000 $ 4,400 19,600 4,400 15,200
3 24,000 8,800 15,200 4,400 10,800
4 24,000 13,200 10,800 4,400 6,400
5 24,000 17,600 6,400 4,400 2,000
Cost ($24,000) – Residual Value ($2,000)
Estimated Useful Life (5 years)
=
Annual
Depreciation
Expense ($4,400)

Units-of-Production Method
Cost – estimated residual value
Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.

$24,000 – $2,000
10,000 hours
= Depreciation per unit, hour, etc.
= $2.20 per hour

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.

Declining-Balance Method
Step 1
Ignoring residual value,
determine the straight-line rate
= $4,800
$24,000 – $2,000
5 years
$4,800
$24,000
= 20%

There’s a shortcut. Simply
divide one by the number of
years (1 ÷ 5 = .20).

Double the straight-line rate.
Step 2
.20 x 2 = .40
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.

Build a table.
Step 3

Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600
$24,000 x .40

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760
$14,400 x .40

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
STOP!

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
If we use this approach in Year 5, we will
end the year with a book value of $1,866.
Remember, the residual value at the end of
Year 5 is expected to be $2,000, so we must
modify our approach.

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110
$3,110 – $2,000

Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110 22,000 2,000
Desired
ending book
value

Comparing Straight-Line With the
Straight-Line
Method
Depreciation
($)
5,000
4,000
3,000
2,000
1,000
0
Life (years)
Declining-Balance
Method
Life (years)
1 2 3 4 1 2 3 4

Revising Depreciation Estimates
A machine purchased for
$130,000 was originally
estimated to have a useful
life of 30 years and a
residual value of $10,000.
The asset has been
depreciated for ten years
using the straight- line
method.
Annual
Depreciation
$130,000 – $10,000
30 years
$4,000 per year

Equipment
130,000
Accumulated
Depreciation
4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000
40,000
Before revising
Book value = $90,000

During the eleventh year, it is estimated that the
remaining useful life is 25 years (rather than 20) and
that the revised estimated residual value is $5,000.
Book value – revised residual value
Revised estimated remaining life
$90,000 – $5,000
25 years
$3,400 revised
annual depreciation
=

Expenditures made to
acquire new plant
assets are known as
capital expenditures.
Capital and Revenue Expenditures

Expenditures to repair or
maintain plant assets that do
not extend the life or enhance
the value are known as
revenue expenditures.

EXPENDITURE
Increases
operating
efficiency or adds
to capacity?
Capital
Expenditure
(Debit fixed asset
account)
Yes
Increases
useful life
(extraordinary
repairs)?
No
Capital Expenditure
(Debit accumulated
depreciation account)
Yes
Revenue
Expenditure
(Debit expense
account for
ordinary
maintenance
and repairs)
No

LIABILITIES
OWNER’S
EQUITY
REVENUES
ASSETS
EXPENSES
CAPITAL
EXPENDITURES
1. Initial cost
2. Additions
3. Betterments
4. Extraordinary
repairs
net income

LIABILITIES
OWNER’S
EQUITY
REVENUES
ASSETS
EXPENSES
net income
Normal and
ordinary repairs
and maintenance
REVENUE
EXPENDITURES

Accounting for Fixed Asset Disposals
When fixed assets lose their usefulness they may be
disposed of in one of the following ways:
1. discarded,
2. sold, or
3. traded (exchanged) for similar assets.
Required entries will vary with type of disposition
and circumstances, but the following entries will
always be necessary:
An asset account must be credited to remove the asset
from the ledger, and the related Accumulated
Depreciation account must be debited to remove it’s
balance from the ledger.

A piece of equipment
acquired at a cost of
$25,000 is fully
depreciation. On February
14, the equipment is
discarded.
Discarding Fixed Assets

Feb. 14 Accumulated Depr.—Equipment 25 000 00
To write off fully depreciated
equipment.
Equipment 25 000 00

Equipment costing $6,000 is depreciation 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
To record current depreciation
on equipment discarded.
Accum. Depreciation—Equipment 150 00
$600 x 3/12

Equipment costing $6,000 is depreciation 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 Accumulated Depr.—Equipment 4 900 00
Loss on Disposal of Fixed Asset 1 100 00
To write off equipment
discarded.
Equipment 6 000 00

Gain or loss will be reported in the income
statement as Other Income or Other Loss.
When fixed assets are sold, the owner may
break even, sustain a loss, or realize a gain.
1. If the sale price is equal to book value, there
will be no gain or loss.
2. If the sale price is less than book value, there
will be a loss equal to the difference.
3. If the sale price is more than book value,
there will be a gain equal to the difference.
Sale of Fixed Assets

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.
Oct. 12 Depreciation Expense—Equipment 750 00
To record current depreciation
on equipment sold.
Accumulated Depr.—Equipment 750 00
$10,000 x ¾
x10%

Assumption 1: The equipment is sold
for $2,250, so there is
no gain or loss.
Oct. 12 Cash 2 250 00
Sold equipment.
Accumulated Depr.—Equipment 7 750 00
Equipment 10 000 00

for $1,000, so there is a
loss of $1,250.
Oct. 12 Cash 1 000 00
Sold equipment.
Equipment 10 000 00
Loss on Disposal of Fixed Assets 1 250 00

for $2,800, so there is a
gain of $550.
Sold equipment.
Equipment 10 000 00
Gain on Disposal of Fixed Assets 550 00
Oct. 12 Cash 2 800 00

Exchanges of Similar Fixed Assets
 Trade-in Allowance (TIA) – amount
allowed for old equipment toward the
purchase price of similar new assets.
 Boot – balance owed on new equipment
after trade-in allowance has been
deducted.
 TIA > Book Value = Gain on Trade
 TIA < Book Value = Loss on Trade
 Gains are never recognized (not
recorded).
 Losses must be recognized (recorded).

CASE ONE (GAIN):
Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100)
TIA > Book Value = Gain
$1,100 – $800 = $300
Boot + Book = Cost of New Equipment
$3,900 + $800 = $4,700
List price of new equipment acquired $5,000
Cost of old equipment traded in $4,000
Accum. depreciation at date of exchange 3,200
Book value at date of exchange $ 800
Gains are not
recognized for
financial reporting.

June 19 Accumulated Depr.—Equipment 3 200 00
Equipment (new equipment) 4 700 00
Equipment (old equipment) 4 000 00
Cash 3 900 00
On June 19, equipment exchanged
at a gain of $300.

CASE TWO (LOSS):
Trade-in allowance, $2,000
Cash paid, $8,000 ($10,000 – $2,000)
TIA<Book Value = Loss
$2,000 – $2,400 = $400
List price of new equipment acquired $10,000
Cost of old equipment traded in $7,000
Accum. depreciation at date of exchange 4,600
Book value at date of exchange $2,400
Losses are
recognized for
financial reporting.

Sept. 7 Accumulated Depr.—Equipment 4 600 00
Equipment (new equipment) 10 000 00
Loss on Disposal of Fixed Assets 400 00
On September 7, equipment
exchanged at a loss of $400.
Equipment (old equipment) 7 000 00
Cash 8 000 00

Natural Resources and
Depletion
Depletion is the process of
transferring the cost of natural
resources to an expense account.

Natural Resources and 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).

Natural Resources and Depletion
Adjusting Entry
Accumulated Depletion 36 000 00
During the current year, 90,000 tons are
mined. The periodic depletion is
$36,000 (90,000 tons x $0.40).
Dec. 31 Depletion Expense 36 000 00

Date Description Debit Credit
Intangible Assets and Amortization
Dec. 31 Amortization Expense 20,000
Patents 20,000
Paid $100,000 for patent rights. The patent life is 11
years and was issued 6 years prior to purchase.
Amortization is the periodic cost expiration of intangible
assets which do not have physical attributes and are not
held for sale (patents, copyrights, and goodwill).
11 years – 6 years = 5-year life
($100,000 / 5 years) = $20,000 per year

Alaska deposit $1,200,000 $ 800,000 $400,000
Wyoming deposit 750,000 200,000 550,000
$1,950,000 $1,000,000 950,000
Total property, plant, and equipment $1,629,000
Intangible assets:
Patents $ 75,000
Goodwill 50,000
Total intangible assets $ 125,000
Discovery Mining Co.
Partial Balance Sheet
December 31, 2006
Accum. Book
Property, plant, and equipment: Cost Depr. Value
Land $ 30,000 $ 30,000
Buildings 110,000 $ 26,000 84,000
Factory equipment 650,000 192,000 458,000
Office equipment 120,000 13,000 107,000
$910,000 $231,000 $ 679,000
Accum. Book
Mineral deposits: Cost Depr. Value

Ratio of Fixed Assets to Long-Term Liabilities
(in millions)
2002 2001
Procter & Gamble
Fixed assets (net) $13,349 $13,095
Long-term debt $11,201 $9,792
Ratio of fixed assets to
long-term liabilities 1.2 1.3
Use: To indicate the margin of safety
to long-term creditors

ch10- Fixed Assets and Intangible Assets.ppt

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