Ch09 wrd12e instructor_final

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c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives

1. Define, classify, and account for the cost of
2.

3.
4.

fixed assets.
Compute depreciation, using the following
methods: straight-line method, units-ofproduction method, and double-decliningbalance method.
Journalize entries for the disposal of fixed
assets.
Compute depletion and journalize the entry
for depletion.

Learning Objectives

5. Describe the accounting for intangible assets,
such as patents, copyrights, and goodwill.

6. Describe how depreciation expense is

reported in an income statement and prepare
a balance sheet that includes fixed assets and
intangible assets.

7. Describe and illustrate the fixed asset

turnover ratio to assess the efficiency of a
company’s use of its fixed assets.

Lear
ning
Obje
Defin
ctive
e, cla
ssify
, an
d acc
o u nt
cost
of fix for the
ed a
ssets

1


Nature of Fixed Assets

o

Fixed assets are long-term or relatively
permanent assets, such as equipment,
machinery, buildings, and land. Other
descriptive titles for fixed assets are plant
assets or property, plant, and equipment.


Nature of Fixed Assets

o

Fixed assets have the following
characteristics:
 They exist physically and, thus, are tangible

assets.

 They are owned and used by the company in

its normal operations.

 They are not offered for sale as part of normal

operations.


Costs of Acquiring Fixed Assets

o

Unnecessary costs that do not increase the
asset’s usefulness are recorded as an expense.
 Vandalism
 Mistakes in installation
 Uninsured theft
 Damage during unpacking and installing
 Fines for not obtaining proper permits from

government agencies


Capital and Revenue Expenditures

o

Expenditures that benefit only the current
period are called revenue expenditures.


Capital and Revenue Expenditures

o Expenditures that improve the asset or extend
its useful life are capital expenditures.


CAPITAL AND REVENUE
EXPENDITURES
Revenue
Expenditures



Normal and
ordinary repairs
and maintenance

Capital
Expenditures



Additions,
improvements,
and extraordinary
repairs

Ordinary Maintenance and Repairs

o On April 9, the firm paid $300 for a tune-up of a
delivery truck.

revenue
expenditure


Asset Improvements

o On May 4, a $5,500 hydraulic lift was installed
on the delivery truck to allow for easier and
quicker loading of heavy cargo.

capital expenditure


Extraordinary Repairs

o 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 by eight years.
Work on the forklift was completed on October
14.

capital
expenditure


CAPITAL AND
REVENUE
EXPENDITURES

Leasing Fixed Assets

o The 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

asset are granted by the lessor.



o

A capital lease is accounted for as if the lessee
has, in fact, purchased the asset. The asset is
then amortized (written off as an expense)
over the life of the capital lease.



o 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, because the lessee is renting
the asset for the lease term.


Lear
ning
Obje
ctive
Com
pute
depr
follo
e
ec
w
meth
od, u ing meth iation, us
and
ods:
i
doub nits-ofstrai ng the
prod
le-de
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th o d

2


Depreciation

o

Over time, most fixed assets (equipment,
buildings, and land improvements) lose their
ability to provide services. The periodic
recording of the cost of fixed assets as an
expense is called depreciation.


Accounting for Depreciation

o

Depreciation can be caused by physical or
functional factors.
 Physical depreciation factors include wear

and tear during use or from exposure to the
weather.
 Functional depreciation factors include

obsolescence and changes in customer needs
that cause the asset to no longer provide
services for which it was intended.


Accounting for Depreciation

o

Two common misunderstandings that exist
about depreciation as used in accounting
include:
 Depreciation does not measure a decline in

the market value of a fixed asset.

 Depreciation does not provide cash to replace

fixed assets as they wear out.


Factors in Computing Depreciation

o

Three factors determine the depreciation
expense for a fixed asset. These three factors
are:
 The asset’s initial cost
 The asset’s expected useful life
 The asset’s estimated residual value


Factors in Computing Depreciation

o

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 also estimated at the
time the asset is placed into service.


FACTORS IN
COMPUTING
DEPRECIATION

Straight-Line Method

o

The straight-line method provides for the
same amount of depreciation expense for
each year of the asset’s useful life.
Annual
=
Depreciation

Cost – Residual Value
Useful Life


 Initial cost: $24,000
 Expected useful life 5 years
 Estimated residual value: $2,000

o The annual straight-line depreciation of $4,400
is computed below:

Annual Depreciation =
Useful Life
$24,000 - $2,000
=
5 years
=

$4,400



o If the preceding equipment was purchased

and placed into service on October 1, the
depreciation for the first year of use would be
$1,100, computed as follows:
$4,400 x 3/12 = $1,100



o

The straight-line percentage can be
determined by dividing 100% by the number
of years of expected useful life, as shown
below.


Units-of-Production Method

o

The units-of-production method provides the
same amount of depreciation expense for
each unit produced or each unit of capacity
used by the asset.
 Step 1. Determine the depreciation per unit as:
Depreciation per Unit =

Total Units of Production

 Step 2. Compute the depreciation expense as:
Depreciation Expense = Depreciation per Unit x Total Units of
Output Used

Units-of-Production Method

o

A depreciable asset costs $24,000. Its
estimated residual value is $2,000, and it is
expected to have a useful life of 10,000
operating hours. During the year, the asset
was operated 2,100 hours.


Double-Declining-Balance Method

o

The double-declining-balance method
provides for a declining periodic expense
over the expected useful life of the asset.



o The double-declining-balance method 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 2.

 Step 3. Compute the depreciation expense by

multiplying the double-declining-balance rate from
Step 2 times the book value of the
asset.
(continued)



o The double-declining-balance rate is

determined by doubling the straight-line rate.

o A shortcut to determining the straight-line rate
is to divide one by the number of years (for
example, 1 ÷ 5 = 0.20).

o Using the double-declining-balance method, a

five-year life results in a 40 percent rate (0.20 ×
2).



o

For the first year, the book value of the
equipment is its initial cost of $24,000.

o

After the first year, the book value (cost minus
accumulated depreciation) declines and, thus,
the depreciation also declines.



o

The double-declining-balance depreciation
for the full five-year life of the equipment is
shown below.

DEPRECIATION STOPS
WHEN BOOK VALUE
EQUALS RESIDUAL VALUE!

STOP



“Forced”
Desired
depreciation
ending
for 5th year book value


o

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:
First year partial
= $9,600 x 3/12 = $2,400
depreciation



o The depreciation for the second year would
then be $8,640, computed as follows:

Second year
depreciation = [40% x ($24,000 – $2,400)]
Second year
depreciation = $8,640



o The double-declining-balance method

provides a higher depreciation in the first year
of the asset’s use, followed by declining
depreciation amounts. Thus, it is called an
accelerated depreciation method.


Comparing Depreciation Methods

Depreciation for Federal Income Tax

o

The Internal Revenue Code specifies the
Modified Accelerated Cost Recovery System
(MACRS) for use by businesses in computing
depreciation for tax purposes.



o

MACRS specifies eight classes of useful life
and depreciation rates for each of the eight
classes. The two most common classes are the
five-year class (includes automobiles and
light-duty trucks) and the seven-year class
(includes most machinery and equipment).



o

For the five-year-class assets, depreciation is
spread over six years, as shown below.


Revising Depreciation Estimates

o

A machine is purchased on January 1, 2013, for
$140,000.



o

At the end of 2014, the asset’s book value is
$88,000, as shown below.



o

During 2015, the company estimates that the
machine’s remaining useful life is eight years
(instead of three) and that its residual value is
$8,000 (instead of $10,000). Depreciation expense
for each of the remaining eight years is
determined as follows:


REVISING
DEPRECIATION
ESTIMATES

Lear
ning
Obje
Journ
ctive
alize
entri
es f o
or th
e

disp
o
fixed sal of
asse
ts

3


Discarding Fixed Assets

o

Equipment acquired at a cost of $25,000 is
fully depreciation at December 31, 2013. On
February 14, 2014, the equipment is
discarded.



o

Equipment costing $6,000, with no residual
value, is depreciated at an annual straight-line
rate of 10%. After the December 31, 2013,
adjusting entry, Accumulated Depreciation—
Equipment has a $4,650 balance. On March 24,
2014, the asset is removed from service and
discarded.



$600 × 3/12


o The discarding of the equipment is then

recorded as shown below. (Note that this is the
second of two entries on March 24.)


Selling Fixed Assets

o

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.

(continued)


o The entry to update the depreciation for the

nine months of the current year is as follows:

(continued)


o

After the current depreciation is recorded, the
book value of the asset is $2,250 ($10,000 –
$7,750).



o After the current depreciation is recorded, the
book value of the asset is $2,250 ($10,000 –
$7,750).


Lear
ning
Obje
Com
ctive
pute
depl
etio
the e on and jo
u
nt r y
for d r nalize
e pl e
tion

4


Natural Resources

o

The process of transferring the cost of natural
resources to an expense account is called
depletion.


Natural Resources
 Step 1: Determine the depletion rate as:

 Step 2: Multiply the depletion rate by the

quantity extracted during the period.


Natural Resources

o

A company paid $400,000 for the mining
rights to a mineral deposit estimated at
1,000,000 tons of ore. During the year, the
company mined 90,000 tons of the mineral
deposit.


Natural Resources

o The depletion expense for the year is
computed as shown below.
 Step 1.

 Step 2.


Natural Resources

o

The adjusting entry to record the depletion is
shown below.


Lear
ning
Obje
ctive
D
intan escribe
gi
th
ible a
e
ssets accoun
ting
, suc
copy
f
h as
right
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ill

5


Intangible Assets

o

Patents, copyrights, trademarks, and goodwill
are long-lived assets that are used in the
operations of a business and not held for sale.
These assets are called intangible assets
because they do not exist physically.


Intangible Assets

o The accounting for intangible assets is similar
to that for fixed assets. The major issues are:
 Determining the initial cost.
 Determining the amortization, which is the amount

of cost to transfer to expense.


Patents

o

The exclusive right granted by the federal
government to produce and sell goods with
one or more unique features is called a patent.
These rights continue in effect for 20 years.


Patents

o

At the beginning of its fiscal year, a business
acquires patent rights for $100,000. The
patent’s remaining useful life is estimated at 5
years. The entry to amortize the patent at the
end of the year is as follows:


Patents

o

Because a patent (as well as other intangible
assets) does not exist physically, it is
acceptable to credit the asset. This approach
is different from physical fixed assets, which
require the use of a contra asset account.


Copyrights and Trademarks

o

The exclusive right granted by the federal
government to publish and sell a literary,
artistic, or musical composition is called a
copyright. A copyright extends for 70 years
beyond the author’s death.


Copyrights and Trademarks

o

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 renewed for 10year periods thereafter.


Goodwill

o

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.


Goodwill

o

Generally accepted accounting principles
(GAAP) permit goodwill to be recorded in the
accounts only if it is objectively determined
by a transaction.


Goodwill

o

A loss should be recorded if the business
prospects of an acquired firm (and the
acquired goodwill) become significantly
impaired. Assume that on December 31,
FaceCard Company has determined that
$250,000 of the goodwill created from the
purchase of Electronic Systems is impaired.


COMPARISON
OF INTANGIBLE
ASSETS

Lear
ning
Obje
Desc
ctive
ribe
how
repo
depr
r te d
ec
prep
i
c
are a n an inco iation ex
p
fixed balance me state ense is
men
shee
asse
t and
t tha
ts an
t
d int
angi includes
ble a
ssets

6


Fixed and Intangible Assets

o
o
o

Intangible assets are usually reported in the
balance sheet in a separate section following
fixed assets.
The balance of 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.


Lear
ning
Obje
ctive
Desc
asse ribe and
t tur
ill
e
us
rn
fficie
ncy o over rat trate the
f a c o i o to a
fixed
s
mpa
ny’s sess the
use o
f its
fixed
asse
ts

7


Fixed Asset Turnover Ratio

o

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

Net Sales
Average Book Value of Fixed
Assets


dixr
en mila
pp g Si ts
A in
se
g

han gixed As
Exc
F


Exchanging Similar Fixed Assets

1. Old equipment is often traded for new

equipment having a similar use. In such cases,
the seller allows the buyer a trade-in
allowance for the old equipment traded in.

2. The remaining balance—the amount owed—is
either paid in cash or recorded as a liability. It
is normally called boot.

Gain on Exchange

(see next slide)

Loss on Exchange

o

This time assume that only a $675 trade-in
allowance was allowed toward the purchase of
the new equipment. Because the market value
of the new equipment is $5,000, the cash paid
on the exchange is $4,325.


an d
et s t s
ss
dA
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ixe ble As
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gi
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