C10 - 1 Learning Objectives 1.Nature of Fixed Assets 2.Accounting for Depreciation 3.Capital and Revenue Expenditures 4.Disposal of Fixed Assets 5.Leasing.

C10 - 1

Learning Objectives

1. Nature of Fixed Assets2. Accounting for Depreciation3. Capital and Revenue Expenditures4. Disposal of Fixed Assets5. Leasing Fixed Assets6. Internal Control of Fixed Assets7. Natural Resources 8. Intangible Assets9. Financial Reporting10. Financial Analysis and Interpretation

Chapter 10Fixed assets and intangible assets

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LIABILITIES

OWNER’SEQUITY

Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues.

REVENUES

ASSETS

EXPENSES

FixedFixedAssetsAssets

Nature of Fixed AssetsNature of Fixed Assets

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Nature of Fixed AssetsNature of Fixed Assets

LIABILITIES

OWNER’SEQUITY

Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues.

REVENUES

ASSETS

EXPENSES

FixedFixedAssetsAssets

All fixed assets except land lose their capacityto provide services. This loss of productive capacity is recognized as depreciation expense.

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Costs of Acquiring Fixed Assets Include:Costs of Acquiring Fixed Assets Include:

Sales tax and freight costs

Installation and assembling

Repairs and reconditioning (used assets)

Testing and modifying

Insurance while asset is in transit

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Vandalism

uninsured theft

Mistakes in installation

Damage during unpacking and installing

fines

Costs of Acquiring Fixed Assets Exclude:Costs of Acquiring Fixed Assets Exclude:

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Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense

minus

Initial Cost $24,000a

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equals


Estimated Residual Value $2,000b

minus


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divided by

Depreciable Cost $22,000

equals



minus


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equals

Estimated Useful Life 5 yearsc

divided by


equals



minus


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Periodic Depreciation Expense $4,400 per year

equals

Estimated Useful Life 5 yearsc

divided by


equals



minus


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Recording DepreciationRecording Depreciation

General Journal

Description Debit Credit

General Ledger

Equipment 24,000Cash 24,000

Equipment

24,000

AAAA

Accum. Depreciation

Depreciation Expense

Record straight-line depreciation for first year. Record straight-line depreciation for first year.

BB

BB

Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.


AA

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General Journal


General Ledger


Depreciation Expense 4,400Accum. Depreciation 4,400

Equipment

24,000

AA

BB

AA

Accum. Depreciation


BB




AA

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AA


General Journal


General Ledger



Equipment

24,000

AA

BB

AA

Accum. Depreciation


BB

$24,000 - $2,000

5 years= $4,400


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General Journal


General Ledger



Equipment

24,000

AA

BB

AA

Accum. Depreciation

4,400 BB


4,400BB

BB

$24,000 - $2,000

5 years= $4,400




AA

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General LedgerGeneral Ledger

Equipment

24,000AA

Accum. Depreciation

4,400 BB


4,400BB

Calculation of Book ValueCalculation of Book Value

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General LedgerGeneral Ledger

Calculation of Book ValueCalculation of Book Value

Equipment

24,000AA

Accum. Depreciation

4,400 BB


4,400BB

Original Cost $24,000Less Accum. Depr. 4,400

Book Value 19,600

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The following four depreciation methods are acceptable for Financial Accounting purposes:

1. Straight-Line

2. Units-of-Production

3. Declining-Balance

4. Sum-of-Years-Digits

Straight-lineStraight-line is far more widely used than other methods.

Declining-balance Declining-balance and sum-of-years-digitssum-of-years-digits are known as accelerated depreciation methods.

Depreciation MethodsDepreciation Methods

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Accum. Depr. Book Value Depr. Book Valueat Beginning at Beginning Expense at End

Year Cost of Year of Year for Year of Year

1 $24,000 $24,000.00 $4,400.00 $19,600.00

2 24,000 $ 4,400.00 19,600.00 4,400.00 15,200.00

3 24,000 8,800.00 15,200.00 4,400.00 10,800.00

4 24,000 13,200.00 10,800.00 4,400.00 6,400.00

5 24,000 17,600.00 6,400.00 4,400.00 2,000.00

Straight - Line DepreciationStraight - Line Depreciation

Cost ($24,000) - Residual Value ($2,000)Cost ($24,000) - Residual Value ($2,000)

Estimated Useful Life (5 years)Estimated Useful Life (5 years)=

Annual DepreciationAnnual DepreciationExpense ($4,400)Expense ($4,400)

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Accum. Depr. Book Value Depr. Book Valueat Beginning at Beginning Expense at End

Year Cost of Year of Year Rate for Year 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 –– 1,110.40 2,000.00

Declining - Balance DepreciationDeclining - Balance Depreciation

Note the Note the accelerationacceleration of depreciation of depreciation expense into expense into early years early years of the life of the asset.of the life of the asset.

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Comparing Depreciation MethodsComparing Depreciation Methods

Straight-LineMethod

De

pre

ciat

ion

($

)

10,000

8,000

6,000

4,000

2,000

0Life (years)

Declining-BalanceMethod

Life (years)

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Depreciation for Federal Income Tax-the Modified Accelerated Cost Recovery System (MACRS)

5-year class

Year Rate (%)

1 20

2 32

3 19.2

4 11.5

5 11.5

6 5.8

100%

Why using MACRS

method for both

financial statement and tax purposes

may hurt a business?

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Revising Depreciation Estimates

Example: (P.397)1. Cost : $130,0002. Residual value: $10,0003. Depreciable cost: $120,0004. Useful life: 30 years5. Have Used for ten years6. Net book value: $90,0007. Revise for another 25 years, residual value: $5,0008. Depreciable cost: $85,0009. Revised annual depreciation expense: $3,400

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Capital and Revenue ExpendituresCapital and Revenue Expenditures

EXPENDITURE

Increases operating

efficiency or adds to

capacity?

YesYes

Capital Expenditure

(Debit fixed asset account)

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EXPENDITURE

Increases operating


capacity?

Increases useful life

(extraordinary repairs)?

NoNo

YesYes

Capital Expenditure


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EXPENDITURE

Increases operating


capacity?



NoNo

YesYes

Capital Expenditure


Capital Expenditure

(Debit accumulated

depreciation account)

YesYes

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Revenue Expenditure

(Debit expense account for

ordinary maintenance and repairs)

EXPENDITURE

Increases operating


capacity?



NoNo NoNo

YesYes

Capital Expenditure


Capital Expenditure

(Debit accumulated

depreciation account)

YesYes


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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

EXPENSES


CAPITAL CAPITAL EXPENDITURESEXPENDITURES

1. 1. Initial costInitial cost2. Additions2. Additions3. Betterments3. Betterments4. Extraordinary 4. Extraordinary

repairsrepairs

net income

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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

EXPENSES


CAPITAL CAPITAL EXPENDITURESEXPENDITURES

Normal and Normal and ordinary repairs ordinary repairs and maintenanceand maintenance

net income

REVENUE REVENUE EXPENDITURESEXPENDITURES

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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:

Asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove its balance from the ledger.

Accounting for Fixed Asset DisposalsAccounting for Fixed Asset Disposals

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DateDate DescriptionDescription DebitDebit CreditCredit

Discarding Fixed AssetsDiscarding Fixed Assets

Accumulated Depreciation 25,000Equipment 25,000

Loss on Disposal of Equipment 1,100Accumulated Depreciation 4,900

Equipment 6,000

Feb. 14

Write off fully depreciated equipment.

Write off partially depreciated equipment.

Mar. 24

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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.

Gain or loss will be reported in the income statement as Other Income or Other Loss.

Sale of Fixed AssetsSale of Fixed Assets

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Selling Fixed Assets

1. Equipment Cost: $10,000

2. Depreciation rate: 10%/year

3. Depreciation expense: $1,000/year

4. Accumulated depreciation($1000*7): $7,000

5. To be sold on Oct. 12 of the eighth year of its use

6. Current year’s depreciation expense(1-9): $750

7. Book value of the asset: $ 2,250

8. If sold • At book value: $2,250

• Below book value: $1,000, loss $1,250

• Above book value: $2,800, gain $550

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Cash 2,250Accumulated Depreciation 7,750

Equipment 10,000

Oct. 12

Sold at book value, for $2,250.

Sold equipment with a book value of $2,250(cost $10,000, accumulated depreciation $7,750).

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Cash 1,000Loss on Disposal of Equipment 1,250Accumulated Depreciation 7,750

Equipment 10,000

Cash 2,800Accumulated Depreciation 7,750

Equipment 10,000Gain on Disposal of Equipment 550

Oct. 12

Sold below book value, for $1,000.

Sold above book value, for $2,800.

Oct. 12

Sold equipment with a book value of $2,250(cost $10,000, accumulated depreciation $7,750).

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Exchanges of Similar Fixed AssetsExchanges of Similar Fixed Assets

Trade-in Allowance (TIA) – amount allowed for old equipment toward the purchase price of similar new assets.

TIA > Book Value = Gain on Trade TIA < Book Value = Loss on Trade GainsGains are never recognized (not

recorded). LossesLosses must be recognized

(recorded).

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Case One (GAIN)Case One (GAIN)

Trade-in allowance, $1,100

Cash paid, $3,900 ($5,000 – $1,100)

TIA > Book Value = Gain

$1,100 – $800 = $300

Cost of New Equipment

$3,900 + $800 = $4,700

Gains are not recognized for financial reporting.


Quoted price of new equipment acquired $5,000

Cost of old equipment traded in $4,000Accum. depreciation at date of exchange 3,200

Book value at date of exchange $ 800

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Case Two (LOSS)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

Cost of New Equipment =

Quoted Price of New Asset $10,000

Quoted price of new equipment acquired $10,000

Cost of old equipment traded in $7,000Accum. depreciation at date of exchange 4,600

Book value at date of exchange $ 2,400

Losses are recognized for financial reporting.

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All leases are either capital leases or operating leases. Capital leases include one or more of the following:1. Lease transfers ownership to the lessee at the end of

the lease term.2. An option for a bargain purchase by the lessee.3. Lease term extends over most of the life of the asset.4. Lease requires rental payments that approximate fair

market value of the asset.Capital leases are accounted for as if the lessee has purchased the asset. Lessee debits an asset account for the fair market value and credits a long-term liability.Operating leases are accounted for as rent expense.

Leasing Fixed AssetsLeasing Fixed Assets

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Natural Resources and DepletionNatural Resources and Depletion

Depletion Expense 36,000Accumulated Depletion 36,000

($400,000 / 1,000,000 tons) = $0.40 per ton90,000 tons x $0.40 = $36,000

Dec. 31

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

Depletion is the periodic allocation of the cost of metal ores and other minerals removed from the earth.

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Intangible Assets and AmortizationIntangible Assets and Amortization

Amortization Expense 20,000Patents 20,000

11 years – 6 years = 5-year life ($100,000 / 5 years) = $20,000 per year

Dec. 31

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).

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Discovery Mining Co.Balance Sheet

December 31, 20--

Accum. BookProperty, plant, and equipment: Cost Depr. Value

Land $ 30,000 $ 30,000Buildings 110,000 $ 26,000 84,000Factory equipment 650,000 192,000 458,000Office equipment 120,000 13,000 107,000

$910,000 $231,000 $ 679,000

Accum. Book Mineral deposits: Cost Depl. Value

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 $1,629,000Intangible assets:

Patents $ 75,000Goodwill 50,000 Total intangible assets $125,000

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Discovery Mining Co.Balance Sheet

December 31, 20--

Accum. BookProperty, plant, and equipment: Cost Depr. Value

Land $ 30,000 $ 30,000Buildings 110,000 $ 26,000 84,000Factory equipment 650,000 192,000 458,000Office equipment 120,000 13,000 107,000

$910,000 $231,000 $ 679,000

Accum. Book Mineral deposits: Cost Depl. Value

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 $1,629,000Intangible assets:

Patents $ 75,000Goodwill 50,000 Total intangible assets $125,000

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Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities

(in millions)1996 1995

Procter & Gamble

Property, plant, equip. (net) $11,118 $11,026Long-term liabilities (debt) $ 4,670 $5,161

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Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities

(in millions)2000 1999

Procter & Gamble

Property, plant, equip. (net) $11,118 $12,626Long-term liabilities (debt) $ 4,670 $6,231

Use: To indicate the margin of safety to long-term creditors

Use: To indicate the margin of safety to long-term creditors

Ratio of fixed assets toRatio of fixed assets tolong-term liabilitieslong-term liabilities 2.4 2.4 2.0 2.0

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HOME WORK

READING:1. Illustrative problem2. Self- examination questions3. Multiple choice

Writing:1. Exercise: 2. Problem : 10-2A

Discussion: Activity 10-2

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The end of chapter 10

C10 - 1 Learning Objectives 1.Nature of Fixed Assets 2.Accounting for Depreciation 3.Capital and Revenue Expenditures 4.Disposal of Fixed Assets 5.Leasing.

Documents

intangible assets slide

used assets

leasing fixed assets

disposal of fixed assets

periodic depreciation

residual value

transit slide

initial cost