Sheet (4)

Tegara English
First year
‫ازهر‬

Chapter
Financial
Accounting 5
The king of Accounting
Edited by Dr/ Magdy Kamel
Tel/ 01273949660

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 Chapter (5) accounting for fixed assets
Plant asset ‫االصول الثابتة‬
 also called property, plant and equipment, or
 are resources that have a physical substance ( a definite size and shape)
 are used in the operations of a business,
 are not intended for sale to customers,
 are expected to provide service to the company for a number of years, except
for land.

Determining the Cost of Plant Assets

 Cost Principle - requires that companies record plant assets at cost.
 Cost consists of all expenditures necessary to acquire an asset and make it
ready for its intended use.
 Revenue expenditure : costs incurred to acquire a plant asset that are
expensed immediately.
 Capital expenditures : costs included in a plant asset account.

1. cost of land
All necessary costs incurred in making land ready for its intended use increase
(debit) the Land account.
Costs typically include:
1) cash purchase price,
2) closing costs such as title and attorney’s fees,
3) real estate brokers’ commissions, and
4) accrued property taxes and other liens on the land assumed by the purchaser.

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2. Land Improvements
Includes all expenditures necessary to make the improvements ready for their
intended use.

 Examples: driveways, parking lots, fences, landscaping, and

underground sprinklers.
 Limited useful lives.
 Expense (depreciate) the cost of land improvements over their useful lives.

3. Buildings:

 Includes all costs related directly to purchase or construction

Purchase costs: ‫تكاليف الشراء‬

 Purchase price, closing costs (attorney’s fees, title insurance, etc.) and
real estate broker’s commission.
 Remodeling and replacing or repairing the roof, floors, electrical wiring, and
plumbing.

Construction costs: ‫تكاليف االنشاء‬

 Contract price plus payments for architects’ fees, building permits, and
excavation costs.

4. Equipment

Include all costs incurred in acquiring the equipment and preparing it for use.

Costs typically include:

 Cash purchase price.
 Sales taxes.

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  Freight charges.
 Insurance during transit paid by the purchaser.
 Expenditures required in assembling, installing, and testing the unit.

Depreciation
 Depreciation is the process of allocating to expense the cost of a plant asset
over its useful (service) life
 Depreciation is a process of cost allocation, not a process of asset valuation.
 The book value—cost less accumulated depreciation
 Land is not a depreciable asset

Depreciation applies to three classes of plant assets:

 Land improvements
 Buildings
 Equipment
Factors in computing depreciation:

 Cost: Plant assets are recorded at cost, in accordance with the cost principle.
 Useful life: an estimate of the expected productive life, also called service life,
of the asset.
 Salvage value: an estimate of the asset's value at the end of its useful life.

Depreciation is generally computed using one of these three methods:

1. Straight-line method
2. Declining-balance method
3. Units-of-activity method

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1. straight-line method
cost - salvage value
 Anuual Depreciation expense = estimated useful live

 Deprecation cost = cost – salvage value

 Book value = cost – accumulated depreciation

Bill’s Pizzas purchased a small delivery truck on January 1, 2012.

Required:
Compute depreciation using the following.

(a) Straight-Line. (b) Units-of-Activity. (c) Declining Balance

a. under straight line method

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2. units of activity method
Companies estimate total units of activity to calculate depreciation cost per unit.

1. depreciation cost = cost – salvage value

cost - salvage value
2. depreciation cost per units = total units of production

3. depreciation expense = depreciation cost per units × units of activity

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3. Declining balance method
 Decreasing annual depreciation expense over the asset’s useful life.
 Double declining-balance rate is double the straight-line rate.
 Rate applied to book value at the beginning of the year

 Depreciation expense = Book Value × rate

 Book value = cost – accumulated depreciation

Depreciation and Income Taxes

 IRS does not require taxpayer to use the same depreciation method on the tax
return that is used in preparing financial statements.
 IRS requires the straight-line method or a special accelerated-depreciation
method called the Modified Accelerated Cost Recovery System (MACRS).

Revising Periodic Depreciation

 Accounted for in the period of change and future periods (Change in Estimate).
 Expenditure During Useful Life

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Ordinary Repairs :
expenditures to maintain the operating efficiency and productive life of the unit.

 Debit - Repair (or Maintenance) Expense.

 Credit: cash

Additions and Improvements

costs incurred to increase the operating efficiency, productive capacity, or useful
life of a plant asset.

 Debit - plant asset

 Credit - cash

Plant assets disposals

Sale of Plant Assets

Compare the book value of the asset with the proceeds received from the sale.
 If proceeds exceed the book value, a gain on disposal occurs.
 If proceeds are less than the book value, a loss on disposal occurs.

Example:
Machinery acquired at a cost of $50,000 is discarded on October 31. However, the
Machinery only had an accumulated depreciation balance of $48,000 on October
31. The entry to record the discard is

solution
Accumulated depreciation – machinery 48,000
Loss on disposal of machinery 2,000
Machinery 50,000

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Example (2)
Paradise Corporation sold equipment that cost $100,000 and had accumulated
depreciation of $60,000 for $45,000. Compute the gain or loss on sale and record
the journal entry for the sale of equipment

Solution
Book value = cost – accumulated depreciation
= 100,000 – 60,000 = 40,000
(-) Sale of equipment = 45,000
= Gain on sale of equipment = 5,000

Journal entries
Cash 45,000
Accumulated depreciation – equipment 60,000
Equipment 100,000
Gain on disposal of equipment 5,000

Example:
A company decides to exchange old equipment with a book value of 81,000
(150,000 cost less accumulated depreciation of 69,000) plus 129,000 cash for new
equipment (similar asset). The fair value of the sale equipment is 90,000. The entry
to record the new equipment would include a debit to

a. Equipment (new) for 210,000 b. Equipment (old) for 150,000

c. Loss on disposal of plant assets for 90,000 d. Equipment (new) for 219,000

Solution

Book value of equipment = 150,000 – 69,000 = 81,000

Sale of equipment 90,000
Gain on sale of old equipment 9,000

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Journal entries
Equipment (new) 219,000
Accumulated depreciation – old equipment 69,000
Gain on disposal of old equipment 9,000
Old equipment 150,000
Cash 129,000

Example
An asset that cost $80,000 and has accumulated depreciation of 60,000 is sold for
12,000. The journal entry would include a
a. Debit to loss on disposal of plant assets of 20,000
b. Debit to loss on disposal of plant assets of 8000
c. Credit to gain on disposal of plant assets of 8000
d. Credit to accumulated depreciation for 60000

Solution
Book value = cost – accumulated depreciation
= 80,000 – 60,000 = 20,000
Sale of plant assets = 12,000
Loss on disposal of plant assets 8,000

Multi choose question

1. The cost of equipment consists of the cash purchase price plus certain related
costs such as sales taxes and freight charges
 True false

2. Cost to construct a plant includes the contract price archiect fee's, building fees,
excavation costs but not interest costs incurred to finance the project.
 True false

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3. The book value of an asset equals its cost less accumulated depreciation.
 True false

4. Under the declining-balance method of depreciation, an asset may not be

depreciated below its estimated salvage value.

 True false

5. Ordinary repairs are expenditures to increase the operating efficiency,

productive capacity, or expected useful life of a plant asset.
 True false

6. Useful life of a copyright is generally shorter than its legal right.

 true; legal life is author's life + 70 years.

7. Unlike other assets that can be sold individually in the marketplace, goodwill can
be identified only with the business as a whole.
 True false

8. The process of allocating the cost of natural resources to expense is called

amortization.
 True false

9. Gains on exchanges of plant assts are recorded in the period the exchange
occurs
 True false

10. When plant assts are exchanged, the cost of the new equipment is always
equal to the fair value of the new equipment plus the cash paid.
 True false

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11. The cost of a factory machine includes all of the following costs EXCEPT
1. invoice price less discount taken
2. sales tax and insurance during shipping
3. three year insurance policy on the machine
4. testing and installation cost

12. The exclusive right to reproduce and sell an artistic or published work is called
1. patent
2. trademark
3. license
4. Copyright

13. Depreciation is a process of asset valuation, not cost allocation.

 True false

14. Depreciation provides for the proper matching of expenses with revenues.
 True false

15. The book value of a plant asset should approximate its fair value.
 True false

16. Depreciation applies to three classes of plant assets: land, buildings, and
equipment.
 True false

17. Depreciation does not apply to a building because its usefulness and revenue-
producing ability generally remain intact over time.
 True false

18. The revenue-producing ability of a depreciable asset will decline due to wear
and tear and to obsolescence.
 True false

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19. Recognizing depreciation on an asset results in an accumulation of cash for
replacement of the asset.
 True false

20. The balance in accumulated depreciation represents the total cost that has
been charged to expense.
 True false

21. Depreciation expense and accumulated depreciation are reported on the

income statement.
 True false

22. Four factors affect the computation of depreciation: cost, useful life, salvage
value, and residual value.
 True false

23. On January 1, a machine with a useful life of 5 years and a salvage value of
$8,000 was purchased for $160,000. What is the depreciation expense in year 2
under the double declining balance method?
a. 38,400
b. 36,480
c. 25,600
d. 24,320

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