CPA, MBA BY RACHELLE AGATHA, CPA, MBA Fixed Assets Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac.

BY R A C H E L L E A G AT H A , C PA , M B A

Fixed Assets

Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

2

1. Define, classify, and account for the cost of fixed assets.

2. Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method.

Objectives:

3

3. Journalize entries for the disposal of fixed assets.

4. Compute depletion and journalize the entry for depletion.

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

Objectives:

4

6. Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.

Objectives:

5

Define, classify, and account for the cost of

fixed assets.

Objective 1

Objective 1

6

Nature of Fixed Assets

Fixed assets are long-term or relatively permanent

assets. They are tangible assets because they exist

physically. They are owned and used by the business and

are not offered for sale as part of normal operations.

7

Fixed Assets as a Percent of Total Assets—Selected Companies

8

Is the purchased item long-lived?

yes

Is the asset used in a productive

purpose?

no

Expense

yes

Fixed Assets

no

Investment

Classifying Costs

9

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 any salvage Grading and leveling Paving a public street

bordering the land

LAND

Cost of Acquiring Fixed Assets

10

Architects’ fees Engineers’ fees Insurance costs incurred during

construction Interest on money borrowed to

finance construction Walkways to and around the

building Sales taxes Repairs (purchase of existing

building) Reconditioning (purchase of

existing building) Modifying for use Permits from government agencies

BUILDING


11

Sales taxes Freight Installation Repairs (purchase of

used equipment) Reconditioning

(purchase of used equipment)

Insurance while in transit

Assembly

Trees and shrubs Fences Outdoor lighting Paved parking

areas


MACHINERY AND EQUIPMENT

LAND IMPROVEMENT

Modification for user Testing for use Permits from

government agencies

12

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

13

Expenditures that benefit only the current period are called

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

Capital and Revenue Expenditures

14

CAPITAL EXPENDITURES1) Additions2) Improvements

3) Extraordinary

repairs

Normal and ordinary repairs and maintenance

REVENUE EXPENDITURES

Operating Expenses

15

Ordinary Maintenance and Repairs

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

Apr. 9 Repairs and Maintenance Exp.300 00Cash 300 00

This is a revenue expenditure/operating

exp

This is a revenue expenditure/operating

exp

16

Asset Improvements

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

May 4 Delivery Truck 5 500 00Cash 5 500 00

This is a capital expenditure


17

Extraordinary Repairs

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 eight years. Work on the forklift was completed on Oct. 14.

Oct. 14 Accum. Depreciation—Forklift 4 500 00Cash 4 500 00



18

Capital or Revenue Expenditure

19

On June 18 GTS Co. paid $1,200 to upgrade a hydraulic lift and $45 for an oil change for one of its delivery trucks. Journalize the entries for the hydraulic lift upgrade and oil change expenditures.

19

June 18 Delivery Truck 1,200Cash 1,200

18 Repairs and Maintenance Exp. 45Cash 45

20

Leasing Fixed Assets

A capital lease is accounted for as if the

lessee has, in fact, purchased the asset.

The asset is then amortized over the life

of the capital lease.

21

Leasing Fixed Assets

A lease that is not classified as a

capital lease for accounting purposes is

classified as an operating lease

(an operating leases is treated as an

expense).

22

Compute depreciation using the following

methods: straight-line method, units-of-

production method, double-declining-balance

method.

Objective 2

Objective 2

23

Over time, fixed assets such as equipment, buildings, and

land improvements lose their ability to provide services. The periodic

transfer of the cost of fixed assets to expense is called

depreciation.

Accounting for Depreciation

24

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 no longer able to provide services at the level for

which it was intended.

Physical and Functional Depreciation

25

Factors in Computing Depreciation

The three factors in determining the amount of depreciation expense to be

recognized each period are: (a) the fixed asset’s initial cost, (b) its expected useful life, and (c)

its estimated value at the end of the useful life.

26

The fixed asset’s estimated value at the end of its useful

life is called the residual value, scrap value, salvage value, or trade-in value. A fixed asset’s residual value

and its expected useful life must be estimated at the time the asset is placed in service.

Residual Value

27

28

88%

2%

7% 3%

Source: Accounting Trends & Techniques, 59th ed., American Institute of Certified Public Accountants, New York, 2005.

Exhibit 5: Use of Depreciation Methods

Straight-line

Units-of-production

Double-declining-balance

Other

29

Straight-Line Method

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

Annual depreciation =

Cost – est residual value Estimated life

30

A depreciable asset cost $24,000. Its estimated residual value is

$2,000 and its estimated life is 5 years.

Annual depreciation =

Cost – est residual valueEstimated life

Annual depreciation = $24,000 – $2,0005 years

Annual depreciation =$4,400

31

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.

32

Equipment that was acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (a) depreciable cost, (b) straight-line rate, and (c) annual straight-line depreciation.(a) $120,000 ($125,000 – $5,000)(b) 10% = (1/10)(c) $12,000 ($120,000 x 10%) or ($120,000

÷ 10 years)

33

Units-of-Production Method

The units-of-production method provides for the same amount of

depreciation expense for each unit produced or each unit of capacity used

by the asset.

Unit depreciation =Cost – estimated residual valueEstimated hours, units, etc.

34

A depreciable asset cost $24,000. Its estimated

residual value is $2,000 and its expected to have an estimated life of 10,000

operating hours.

Hourly depreciation =$24,000 – $2,00010,000 estimated hours

Hourly depreciation =

$2.20 hourly depreciation

Hourly depreciation =

Cost – estimated residual valueEstimated hours

35

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.

36

Equipment acquired at a cost of $180,000 has an estimated residual value of $10,000, an estimated useful life of 40,000 hours, and was operated 3,600 hours during the year. Determine the (a) depreciable cost, (b) depreciation rate, and (c) the units-of-production depreciation for the year.

(a) $170,000 ($180,000 – $10,000)(b) $4.25 per hour ($170,000/40,000

hours)(c) $15,300 (3,600 hours x $4.25)

37

Double-Declining-Balance Method

The double-declining-balance method provides for a declining periodic

expense over the estimated useful life

of the asset.

38

A double-declining balance rate is determined by

doubling the straight-line rate. A shortcut to

determining the straight-line rate is to divide one by the

number of years (1/5 = .20). Hence, using the double-

declining- balance method, a five-year life results in a 40

percent rate (.20 x 2).

39

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. Continuing with the

example where the fixed asset cost $24,000 and has

an expected residual value of $2,000, a table can be built.

40

$24,000 x .40

Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End1$24,000 40%$9,600

41

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760

Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End

$14,400 x .40

42

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,640


43

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,184


44

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,110


45

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,1105 3,110 40% 1,244 22,134 1,866


STOPDEPRECIATION STOPS WHEN

BOOK VALUE EQUALS RESIDUAL VALUE!

46

1$24,000 40%$9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,6403 8,640 40% 3,456 18,816 5,1844 5,184 40% 2,074 20,890 3,1105 3,110 – $2,0001,110 22,000 2,000


Desired ending book value

“Forced” annual depreciation

47

Equipment that was acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (a) depreciable cost, (b) double-declining-balance rate, and (c)

double-declining balance depreciation for the first year.(a) $120,000 ($125,000 – $5,000)

(b) 20% [(1/10) x2](c) $25,000 ($125,000 x 20%)

48

Comparing Depreciation Methods

49

Comparing Depreciation Methods

50

Depreciation for Federal Income Tax

The Internal Revenue Code specifies the Modified

Accelerated Cost Recovery System

(MACRS) for use by businesses in computing

depreciation for tax purposes.

51

MACRS specifies eight classes of useful life and

depreciation rates for each class. The two most

common classes are the 5-year class (includes

automobiles and light duty trucks) and the 7-year class (includes most machinery

and equipment).

52

A machine purchased for $140,000 was originally estimated to have a useful life of five years and a residual value of $10,000.

The asset has been depreciated for two years using the straight-line method.

Revising Depreciation Estimates

$140,000 – $10,000

5 years

Annual Depreciation (S/L)

=

$26,000 per yearAnnual Depreciation (S/L)

=

53

At the end of two years, the asset’s book value is $88,000, determined as

follows:

Asset cost $140,000Less accumulated depreciation

($26,000 per year x 2 years) 52,000 Book value, end of second year$

88,000

54

During the third year, the company estimates that the remaining useful life is eight years (instead of three) and that the

residual value is $8,000 (instead of $10,000). Depreciation expense for each of the remaining eight year is determined as

follows: Book value, end of second year $88,000Less revised estimated residual value 8,000Revised remaining depreciation cost$80,000

Revised annual depreciation expense($80,000 ÷ 8 years)

$10,000

55

A warehouse with a cost of $500,000 has an estimated residual value of $120,000, an estimated useful life of 40 years, and is

depreciated by the straight-line method. (a) Determine the amount of annual

depreciation. (b) Determine the book value at the end of the 20th year of use. (c) If at

the start of the 21st year it is estimated that the remaining life is 25 years and that the residual value is $150,000, determine the

depreciation expense for each of the remaining 25 years.

56

a. $9,500 [($500,000 – $120,000)/40]

b. $310,000 [$500,000 – ($9,500 x 20)]

c. $6,400 [310,000 – $150,000)/25]

57

Journalize entries for the

disposal of fixed assets.

Objective 3

Objective 3

58

Discarding Fixed Assets

A piece of equipment acquired at a cost of $25,000 is fully depreciation. On

February 14, the equipment is discarded.

Feb.14 Accumulated Depr.—Equipment25 000 00

Equipment 25 000 00To write off equipment

discarded.

59

Equipment costing $6,000 is depreciated 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 Accum. Depr.—Equipment 150 00

To record current

depreciation on

equipment

discarded.

$600 x 3/12$600 x 3/12

60

The discarding of the equipment is then recorded by the following

entry:

Mar.24 Accum. Depreciation—Equipment 4 900 00Loss on Disposal of Fixed Assets 1 100 00

Equipment 6 000 00

To write off equipment discarded.

61

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 and

needs to be updated.

Selling Fixed Assets

Oct.12 Depreciation Expense—Equipment 750 00

Accum. Depr.—Equipment 750 00To record current

depreciation on equipment sold.

$10,000 x ¾ x10%

$10,000 x ¾ x10%

62

The equipment is sold on October 12 for $2,250. No gain or loss.

Oct.12 Cash 2 250 00Accum. Depreciation—Equipment 7 750 00

Equipment 10 000 00

Sold equipment at book value.

Assumption 1

63

Oct.12 Cash 1 000 00Accum. Depreciation—Equipment 7 750 00Loss on Disposal of Fixed Assets1 250 00

Equipment 10 000 00

Sold equipment at a loss.

The equipment is sold on October 12 for $1,000; a loss of $1,250.

Assumption 2

64

Oct.12 Cash 2 800 00Accum. Depreciation—Equipment 7 750 00

Equipment 10 000 00

Sold equipment at a gain.

The equipment is sold on October 12 for $2,800; a gain of $550.

Gain on Disp. of Fixed Assets 550 00

Assumption 3

65

Equipment was acquired at the beginning of year at a cost of $91,000. The equipment was depreciated using the straight-line method based upon an estimated useful life of 9 years and an estimated residual value of $10,000.

a. What was the depreciation for the first year?

b. Assuming the equipment was sold at the end of the second year for $78,000, determine the gain or loss on sale of the equipment.

c. Journalize the entry to record the sale.

66

a. $9,000 [($91,000 – $10,000)/9]

b. $5,000 gain; $78,000 – [$91,000 – ($9,000 x 2)]

c. Cash 78,000Accum. Depreciation—Equipment 18,000

Equipment 91,000Gain on Disposal of Fixed Assets

5,000

67

Exchanging Fixed Assets

When old equipment is traded for new equipment, the seller often

allows the buyer a trade-in allowance for the old equipment traded. The remainder, the boot, is either paid in cash or recorded

as a liability.

68

Gains on exchanges of similar fixed assets are

not recognized for financial reporting

purposes.

IMPORTANT!

69

On June 19, assume that new equipment being purchased has a list price of $5,000.

The dealer allows a trade-in allowance of $1,100 on the old, similar equipment. The old equipment cost $4,000

and has a book value of $800.

70

Two Methods of Determining Cost

Method One

List price of new equipment $5,000

Trade-in allowance $1,100Book value of old equipment 800Unrecognized gain on exchange (300)Cost of new equipment $4,700

71

Method Two

Book value of old equipment $ 800Cash paid at date of exchange 3,900Cost of new equipment $4,700

Note that either method provides the same cost for the new equipment.

72

On June 19, equipment was exchanged at a gain of $300.

June19 Accum. Depreciation—Equipment 3 200 00

Equipment (old equipment) 4 000 00

To record exchange of equipment.

Cash 3 900 00

Equipment (new equipment) 4 700 00

73

Losses on Exchanges

For financial reporting purposes, losses are recognized on

exchange of similar fixed assets if the trade-in allowance is less than

the book value of the old equipment. On September 7, new

equipment was acquired by trading in old equipment with a

cost of $7,000 and a book value of $2,400, and giving a cash

payment of $8,000.

74

Cost of old equipment $7,000Accumulated depreciation at date of exchange 4,600Book value at September 7, date of exchange $2,400Trade-in allowance on old equipment 2,000Loss on exchange $ 400

Sept7 Accum. Depreciation—Equipment4 600 00Equipment 10 000 00Loss on Disposal of Fixed Assets 400 00

Equipment 7 000 00Cash 8 000 00

To record exchange of equipment with loss.

75

On the first day of the fiscal year, a delivery truck with a list price of $75,000 was acquired in exchange for an old delivery truck and $63,000 cash. The old truck had a cost of $50,000 and accumulated depreciation of $39,500.

a. Determine the cost of the new truck for financial reporting purposes.

b. Journalize the entry to record the exchange.

76

a. $73,500

List price of new truck $75,000 Trade-in allowance on old truck

($75,000 – $63,000) $12,000Book value of old truck

($50,000 – $39,500) 10,500

Unrecognized gain on exchange 1,500)

Cost of new truck $73,500

(Continued)

or

77

Book value of old truck ($50,000 – $39,5000) $10,500

Plus cash paid at date of exchange 63,000

Cost of new truck $73,500b. Truck (new) 73,500

Accum Dep Truck (old) 39,500Truck (old) 50,000

Cash 63,000

78

Compute depletion and journalize the

entry for depletion.

Objective 4

Objective 4

79

The process of transferring the cost of natural resources to an

expense account is called depletion.

Natural Resources

80

Recording 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).

81

Dec. 31 Depletion Expense 36 000 00Accumulated Depletion 36 000 00

Depletion of

mineral deposit.

Adjusting Entry

If 90,000 tons are mined during the year, an adjusting entry is required at the end of the accounting period.

82

Earth’s Treasures Mining Co. acquired mineral rights for $45,000,000. The mineral deposit is estimated at 50,000,000 tons. During the current year, 12,600,000 tons were mined and sold.

a. Determine the depletion rate.b. Determine the amount of depletion

expense for the current year.c. Journalize the adjusting entry on

December 31 to recognize the depletion expense.

83

a. $0.90 per ton = $45,000,000/50,000,000 tons

b. $11,340,000 – (12,600,000 tons x $0.90 per ton)

c. Dec. 31 Depletion Expense11,340,000Accumulated

Depletion11,340,000

Depletion of mineral deposit.

84

Describe the accounting for

intangible assets, such patents,

copyrights, and goodwill.

Objective 5

Objective 5

85

Intangible Assets

Patents, copyrights, trademarks, and goodwill are

long-lived assets that are useful in the operations of a

business and not held for sale. These assets are called intangible assets because they do not exist physically.

86

The exclusive right granted by the federal

government to manufacturers to produce and sell goods with one or more unique features is a

patent. These rights continue in effect for 20

years.

87

At the beginning of its fiscal year, a business acquires a patent right for

$100,000. Its remaining useful life is estimated at 5 years.

Journalizing Amortization of a Patent

Dec. 31 Amortization Expense—Patents20 000 00Patents 20 000 00

Patent

amortization

($100,000/5).

Adjusting Entry

88

Dec. 31 Amortization Expense—Patents20 000 00Patents 20 000 00

Patent

amortization

($100,000/5).

Adjusting Entry

Because a patent (and other intangible assets) does not exist physically, it is acceptable to

credit the asset. This approach is different from physical fixed assets that require the use of a

contra asset account.

89

The exclusive right granted by the federal government to

publish and sell a literary, artistic, or musical

composition is a copyright. A copyright extends for 70 years beyond the author’s

death.

Copyright

90

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 can

be renewed every 10 year period thereafter.

Trademark

91

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.

10-5

Goodwill

92

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

transaction.

93

Impaired Goodwill

A loss should be recorded if the business prospects of the acquired firm (and the acquired goodwill) become significantly

impaired.

Mar. 19 Loss from Impaired Goodwill50 000 00Goodwill 50 000 00

Impaired

goodwill.

94

On December 31 it was estimated that goodwill of $40,000 was impaired. In

addition, a patent with an estimated useful economic life of 12 years was acquired for

$484,000 on July 1.a. Journalize the adjusting entry on

December 31, for the impaired goodwill.

b. Journalize the adjusting entry on December 31 for the amortization of the patent rights.

95

a.Dec. 31 Loss from Impaired Goodwill40,000Goodwill 40,000

Impaired goodwill.

b.Dec. 31 Amortization Expense—Patents3,500Patents 3,500

Amortized patent rights[($84,000/12) x (6/12)].

96

Describe how depreciation expense

is reported in an income statement, and

prepare a balance sheet that includes

fixed assets and intangible assets.

Objective 6

Objective 6

97

The fixed assets may be shown at their net amount.

The amount of each major class of fixed assets should be disclosed in the balance sheet or in notes.

Office equipment $125,750Less accumulated depreciation 86,300 Net book value $ 39,450

98

The cost of mineral rights or ore deposits is normally shown as part of the fixed asset section of the balance sheet. The related accumulated depletion should also be disclosed.

Intangible assets are usually reported (net of amortization) in the balance sheet in a separate section immediately following fixed assets.

99

Fixed Assets and Intangible Assets in the Balance Sheet

100

Fixed Asset Turnover Ratio

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:


Revenue

Average Book Value of Fixed Assets

=

101

Financial Analysis and Interpretation

For Marriott International, Inc. (in millions)


Revenue

Average Book Value of Fixed Assets

=


$11,550

($2,341 + 2,389)/2 =


= 4.88

Conclusion: For every dollar of fixed assets, Marriott earns $4.88 of revenue.

Summary

Classification of Fixed Assets

Depreciation Methods

Journalize related entries

Depletion

Intangibles

Financial Statement

presentation

CPA, MBA BY RACHELLE AGATHA, CPA, MBA Fixed Assets Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac.

Documents

cost of fixed assets

fixed assets machinery

disposal of fixed assets

intangible assets

permanent assets

mba fixed assets slides

duchac slide

capital expenditures