Fixed Assets and Intangible Assets
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.
o Fixed assets have the following characteristics:
1. They exist physically and, thus, are tangible assets.
2. They are owned and used by the company in its normal operations.
3. 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 improve the asset or extend its useful life are capital expenditures.
o Expenditures that benefit only the current period are called revenue expenditures.
Capital Expenditures - Additions, improvements, and extraordinary repairs
Revenue Expenditures - Normal and ordinary repairs and maintenance
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.
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.
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 to 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
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.
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
o The units-of-production method provides same amount of depreciation expense for each
unit produced or each unit of capacity used by the asset.
Step 1. Depreciation per unit = Cost – Residual Value / Total Units of Production
Step 2. Depreciation expense = Depreciation per Unit x Total Units of Output
Used
o The double-declining-balance method provides for a declining periodic expense over the
expected useful life of the asset.
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.
Determined by doubling the straight-line rate.
A shortcut to determining the straight-line rate is to divide one by the number of
years (for example, 1 / 5 = 0.20)
Using the double-declining-balance method, a five-year life results in a 40
percent rate (0.20 x 2)
Book value = Cost – Accumulated Depreciation
If book value declines, the depreciation also declines.
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.
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).
Natural Resources
o The process of transferring cost of natural resources to an expense account is called
depletion.
Depletion rate = Cost of Resource / Estimated Total Units of Resource
Depletion expense = Depletion Rate x Quantity Extracted
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.
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.
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.
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 10-year
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.
o GAAP permit goodwill to be recorded in the accounts only if it is objectively determined
by a transaction.
Fixed and Intangible Assets
o Intangible assets are usually reported in the balance sheet in a separate section
following fixed assets.
o The balance of each class of intangible assets should be disclosed net of any
amortization.
o The cost and related accumulated depletion of mineral rights are normally shown as part
of the Fixed Assets section of the balance sheet.
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
asset.
FAT = Net Sales / Average Bool Value of Fixed Assets
