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Chapter 10

Fixed Assets and


Intangible Assets
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division


of Thomson Learning. All rights reserved.
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Objectives
Objectives
1. Define fixed assets and describe the accounting for
their cost.
After
After studying
2. Compute depreciation, studying this
using thethis
following methods:
chapter,
chapter,
straight-line method, you
you should
should method, and
units-of-production
declining-balance method.
be able to:
be able to:
3. Classify fixed asset costs as either capital
expenditures or revenue expenditures.
4. Journalize entries for the disposal of fixed assets.
5. Define a lease and summarize the accounting rules
related to the leasing of fixed assets.
Objectives
Objectives
6. Describe internal controls over fixed assets.
7. Compute depletion and journalize the entry for
depletion.
8. Describe the accounting for intangible assets,
such as patents, copyrights, and goodwill.
9. Describe how depreciation expense is
reported in an income statement, and prepare
a balance sheet that includes fixed assets and
intangible assets.
10. Compute and interpret the ratio of fixed assets
to long-term debt.
Nature
Nature of
of Fixed
Fixed Assets
Assets
Fixed
Fixed assets
assets are
are long
long term
term or
or
relatively
relatively permanent
permanent assets
assets
Fixed
Fixed assets
assets are
are tangible
tangible assets
assets
because
because they
they exist
exist physically.
physically.
They
They are
are owned
owned and
and used
used byby the
the
business
business and
and are
are not
not held
held for
for sale
sale
as
as part
part of
of normal
normal operations.
operations.
Classifying
Classifying Costs
Costs
Is the purchased
item long-lived?
Yes No

Is the asset used in Expense


a productive
purpose?
Yes No

Fixed Assets Investment


Land
Land
•• Purchase
Purchase price
price
•• Sales
Sales taxes
taxes
•• Permits
Permits from
from government
government
agencies
agencies
•• Broker’s
Broker’s commissions
commissions
•• Title
Title fees
fees
•• Surveying
Surveying fees
fees
Land
Land
•• Purchase
Purchase priceprice
•• Sales •• Delinquent
taxes Delinquent real
real estate
estate taxes
taxes
Sales taxes
•• Permits •• from
Razing
Razing or
or removing
removing
government
Permits from government
agenciesunwanted
agencies unwanted buildings,
buildings, less
less the
the
•• Broker’s salvage
salvage
Broker’s commissions
commissions
•• •• Grading
Grading and
and leveling
leveling
Title fees
Title fees
•• •• Paving
Paving aa public
public street
street
Surveying
Surveying fees
fees
bordering
bordering thethe land
land
Buildings
Buildings
 Architects’ fees
 Engineers’ fees
 Insurance costs incurred
during construction
 Interest on money
borrowed to finance
construction
 Walkways to and
around the building
Buildings
Buildings
 Sales taxes
 Repairs (purchase of
existing building)
 Reconditioning
(purchase of an existing
building)
 Modifying for use
 Permits from
governmental agencies
Land Improvements
• Trees and shrubs
• Fences
• Parking areas
• Outdoor lighting
• Concrete sewers and drainage
• Paved parking areas
Machinery
Machinery and
and Equipment
Equipment
• Sales taxes
• Freight
• Installation
• Repairs (purchase of used
equipment)
• Reconditioning (purchase
of used equipment)
Machinery
Machinery and
and Equipment
Equipment
• Insurance while in transit
• Assembly
• Modifying for use
• Testing for use
• Permits from governmental
agencies
Cost
Cost of
of Acquiring
Acquiring Fixed
Fixed Assets
Assets Excludes:
Excludes:
 Vandalism
 Mistakes in installation
 Uninsured theft
 Damage during unpacking and installing
 Fines for not obtaining proper permits from
government agencies
Nature
Nature of
of Depreciation
Depreciation
All
All fixed
fixed assets
assets except
except land
land lose
lose their
their capacity
capacity
to
to provide
provide services.
services. This
This loss
loss of
of productive
productive
capacity
capacity isis recognized
recognized as
as Depreciation
Depreciation Expense.
Expense.

Physical
Physical depreciation
depreciation occurs
occurs from
from wear
wear and
and tear
tear
while
while in
in use
use and
and from
from the
the action
action of
of the
the weather.
weather.
Functional
Functional depreciation
depreciation occurs
occurs when
when aa fixed
fixed asset
asset
isis longer
longer able
able to
to provide
provide services
services at
at the
the level
level for
for
which
which itit was
was intended,
intended, e.g.,
e.g., personal
personal computer.
computer.
Depreciation
Depreciation Expense
Expense Factors
Factors

Initial Cost - Residual Value = Depreciable Cost

Useful Life

1 2 3 4 5

Periodic Depreciation
Expense
Use
Use of
of Depreciation
Depreciation Methods
Methods

Other Units-of-Production
8% 5%
4%
Declining-
Balance
83%

Straight-Line

Source: Accounting Trends & Techniques, 56th . ed., American Institute of


Certified Public Accountants, New York, 2002.
Facts
Facts
Original
Original Cost.....…………..
Cost.....………….. $24,000
$24,000
Estimated
Estimated Life
Life inin years…..
years….. 55 years
years
Estimated
Estimated Life
Life inin hours…..
hours….. 10,000
10,000
Estimated
Estimated Residual
Residual Value...
Value... $2,000
$2,000
Straight-Line
Straight-Line Method
Method

Cost – estimated residual value


Estimated life
= Annual depreciation
Straight-Line
Straight-Line Method
Method

$24,000 – $2,000
5 years
= $4,400 annual depreciation
Straight-Line
Straight-Line Rate
Rate

$24,000 – $2,000
= $4,400
5 years

$4,400
= 18.3%
$24,000
Straight-Line
Straight-Line Method
Method
The
The straight-line
straight-line method
method isis widely
widely usedused
by
by firms
firms because
because itit isis simple
simple andand itit
provides
provides aa reasonable
reasonable transfer
transfer of
of cost
cost to
to
periodic
periodic expenses
expenses ifif the
the asset
asset isis used
used
about
about the
the same
same from
from period
period to to period.
period.
Straight-Line
Straight-Line Method
Method
Accum. Depr. Book Value Depr. Book Value
at Beginning at Beginning Expense at End
Year Cost of Year of Year for Year of Year

1 $24,000 $24,000 $4,400 $19,600


2 24,000 $ 4,400 19,600 4,400 15,200
3 24,000 8,800 15,200 4,400 10,800
4 24,000 13,200 10,800 4,400 6,400
5 24,000 17,600 6,400 4,400 2,000

Cost ($24,000) – Residual Value ($2,000) Annual


= Depreciation
Estimated Useful Life (5 years) Expense ($4,400)
Units-of-Production
Units-of-Production Method
Method

Cost – estimated residual value


Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.
Units-of-Production
Units-of-Production Method
Method

$24,000 – $2,000
10,000 hours
= Depreciation perper
= $2.20 unit, hour, etc.
hour
Units-of-Production
Units-of-Production Method
Method
The
The units-of-production
units-of-production method
method
isis more
more appropriate
appropriate thanthan the
the
straight-line
straight-line method
method whenwhen thethe
amount
amount of of use
use of
of aa fixed
fixed asset
asset
varies
varies from
from year
year to to year.
year.
Declining-Balance
Declining-Balance Method
Method

Step
Step 11

Ignoring residual value,


determine the straight-line rate
$24,000 – $2,000
= $4,800
5 years
$4,800
= 20%
$24,000
Declining-Balance
Declining-Balance Method
Method
There’s
There’s aa shortcut.
shortcut. Simply
Simply
divide
divide one
one byby the
the number
number ofof
years
years (1
(1 ÷÷ 55 == .20).
.20).
Declining-Balance
Declining-Balance Method
Method

Step
Step 22

Double the straight-line rate.


.20 x 2 = .40
For
For the
the first
first year,
year, the
the cost
cost of
of the
the asset
asset isis
multiplied
multiplied by
by 40
40 percent.
percent. After
After the
the first
first year,
year,
the
the declining
declining book
book value
value of
of the
the asset
asset isis
multiplied
multiplied 40 40 percent.
percent.
Declining-Balance
Declining-Balance Method
Method

Step
Step 33

Build a table.
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600

$24,000
$24,000 xx .40
.40
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760

$14,400
$14,400 xx .40
.40
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 STOP!
$24,000
STOP! 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
Declining-Balance
Declining-Balance Method
Method
IfIf we
Book we use
use this
Value this approach
approach inin Year
Year 5,
5, we
Accum. we will
will
end
end the
Beginningthe year
year with aa book
book value
withAnnual value of
of $1,866.
Deprec.$1,866.
Book Value
Year Remember,
of Year
Remember, the
the residual
Rate Deprec. value
residual at
at the
the end
Year-End
value end of
Year-End
of
1 Year
Year 55 isis40%
$24,000 expected
expected to
to be
$9,600 be $2,000,
$9,600so
$2,000, so we
we$14,400
2 14,400 must
must modify
40%modify our
our approach.
5,760 approach.
15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110

$3,110
$3,110 –– $2,000
$2,000
Declining-Balance
Declining-Balance Method
Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110 22,000 2,000

Desired
ending book
value
Comparing
Comparing Straight-Line
Straight-Line With
With the
the
Declining-Balance
Declining-Balance Method
Method
Straight-Line Declining-Balance
Method Method
5,000
Depreciation ($)

4,000

3,000

2,000

1,000

0 1 2 3 4 1 2 3 4
Life (years) Life (years)
Revising
Revising Depreciation
Depreciation Estimates
Estimates
AA machine
machine purchased
purchased forfor
$130,000 Annual
$130,000 was was originally
originally
estimated Depreciation
estimated to to have
have aa useful
useful
life
life of
of 30
30 years
years and
and aa $130,000 – $10,000
residual
residual value
value of
of $10,000.
$10,000. 30 years
The
The asset
asset has
has been
been $4,000 per year
depreciated
depreciated for for ten
ten years
years
using
using the
the straight-
straight-
line
line method.
method.
Revising
Revising Depreciation
Depreciation Estimates
Estimates
Accumulated
Equipment Depreciation
130,000 4,000
4,000
4,000
4,000
Book value = $90,000 4,000
4,000
4,000
4,000
4,000
Before 4,000
Before revising
revising 40,000
Revising
Revising Depreciation
Depreciation Estimates
Estimates
During the eleventh year, it is estimated that the
remaining useful life is 25 years (rather than 20) and
that the revised estimated residual value is $5,000.

Book value – revised residual value


Revised estimated remaining life
$90,000 – $5,000 $3,400 revised
= annual depreciation
25 years
Capital
Capital and
and Revenue
Revenue Expenditures
Expenditures

Expenditures
Expenditures made
made toto
acquire
acquire new
new plant
plant
assets
assets are
are known
known as
as
capital
capital expenditures.
expenditures.
Capital
Capital and
and Revenue
Revenue Expenditures
Expenditures
Expenditures
Expenditures to to repair
repair or
or
maintain
maintain plant
plant assets
assets that
that do
do
not
not extend
extend the
the life
life or
or enhance
enhance
the
the value
value are
are known
known as as
revenue
revenue expenditures.
expenditures.
Capital
Capital and
and Revenue
Revenue Expenditures
Expenditures
EXPENDITURE
Revenue
Increases Expenditure
Increases (Debit expense
operating useful life No account for
efficiency or adds No
(extraordinary ordinary
to capacity? repairs)? maintenance
and repairs)
Yes Yes
Capital
Expenditure Capital Expenditure
(Debit fixed asset (Debit accumulated
account) depreciation account)
Capital
Capital and
and Revenue
Revenue Expenditures
Expenditures
LIABILITIES

CAPITAL
ASSETS OWNER’S
EXPENDITURES EQUITY

net income
1.1.Initial
Initialcost
cost
2.2.Additions
Additions EXPENSES REVENUES
3.3.Betterments
Betterments
4.4.Extraordinary
Extraordinary
repairs
repairs
Capital
Capital and
and Revenue
Revenue Expenditures
Expenditures
LIABILITIES

ASSETS OWNER’S
EQUITY

net income

REVENUE EXPENSES REVENUES


EXPENDITURES

Normal and
ordinary repairs
and maintenance
Accounting
Accounting for
for Fixed
Fixed Asset
Asset Disposals
Disposals
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:
An asset account must be credited to remove the asset
from the ledger, and the related Accumulated
Depreciation account must be debited to remove it’s
balance from the ledger.
Discarding
Discarding Fixed
Fixed Assets
Assets

A
A piece
piece of
of equipment
equipment
acquired
acquired atat aa cost
cost of
of
$25,000
$25,000 isis fully
fully
depreciation.
depreciation. On On
February
February 14, 14, the
the
equipment
equipment isis discarded.
discarded.
Discarding
Discarding Fixed
Fixed Assets
Assets

Feb. 14 Accumulated Depr.—Equipment 25 000 00


Equipment 25 000 00
To write off fully depreciated
equipment.
Discarding
Discarding Fixed
Fixed Assets
Assets
Equipment
Equipment costing
costing $6,000
$6,000 isis depreciation
depreciation at
at an
an
annual
annual straight-line
straight-line rate
rate of
of 10%.
10%. After
After the
the
adjusting
adjusting entry,
entry, Accumulated
Accumulated Depreciation—
Depreciation—
Equipment
Equipment had
had aa $4,750
$4,750 balance.
balance. The
The equipment
equipment
was
was discarded
discarded onon March
March 24.
24.
Mar. 24 Depreciation Expense.—Equipment 150 00
Accum. Depreciation—Equipment 150 00
To record current depreciation $600
$600xx3/12
3/12
on equipment discarded.
Discarding
Discarding Fixed
Fixed Assets
Assets
Equipment
Equipment costing
costing $6,000
$6,000 isis depreciation
depreciation atat an
an
annual
annual straight-line
straight-line rate
rate of
of 10%.
10%. After
After the
the
adjusting
adjusting entry,
entry, Accumulated
Accumulated Depreciation—
Depreciation—
Equipment
Equipment had
had aa $4,750
$4,750 balance.
balance. The
The
equipment
equipment was
was discarded
discarded on on March
March 24.
24.

Mar. 24 Accumulated Depr.—Equipment 4 900 00


Loss on Disposal of Fixed Asset 1 100 00
Equipment 6 000 00
To write off equipment
discarded.
Sale
Sale of
of Fixed
Fixed Assets
Assets
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
Sale of
of Fixed
Fixed Assets
Assets
Equipment
Equipment costing
costing $10,000
$10,000 isis depreciated
depreciated at at an
an
annual
annual straight-line
straight-line rate
rate of
of 10%.
10%. TheThe
equipment
equipment isis sold
sold for
for cash
cash on
on October
October 12.
12.
Accumulated
Accumulated Depreciation
Depreciation (last(last adjusted
adjusted
December
December 31)31) has
has aa balance
balance of of $7,000.
$7,000.
Oct. 12 Depreciation Expense—Equipment 750 00
Accumulated Depr.—Equipment 750 00
To record current depreciation
$10,000
$10,000 xx ¾
¾
on equipment sold.
x10%
x10%
Sale
Sale of
of Fixed
Fixed Assets
Assets
Assumption
Assumption 1:
1: The
The equipment
equipment isis sold
sold
for
for $2,250,
$2,250, soso there
there isis
no
no gain
gain or
or loss.
loss.
Oct. 12 Cash 2 250 00
Accumulated Depr.—Equipment 7 750 00
Equipment 10 000 00
Sold equipment.
Sale
Sale of
of Fixed
Fixed Assets
Assets
Assumption
Assumption 2:
2: The
The equipment
equipment isis sold
sold
for
for $1,000,
$1,000, so
so there
there isis aa
loss
loss of
of $1,250.
$1,250.
Oct. 12 Cash 1 000 00
Accumulated Depr.—Equipment 7 750 00
Loss on Disposal of Fixed Assets 1 250 00
Equipment 10 000 00
Sold equipment.
Sale
Sale of
of Fixed
Fixed Assets
Assets
Assumption
Assumption 2:
2: The
The equipment
equipment isis sold
sold
for
for $2,800,
$2,800, so
so there
there isis aa
gain
gain of
of $550.
$550.
Oct. 12 Cash 2 800 00
Accumulated Depr.—Equipment 7 750 00
Equipment 10 000 00
Gain on Disposal of Fixed Assets 550 00
Sold equipment.
Exchanges
Exchanges of
of Similar
Similar Fixed
Fixed Assets
Assets
 Trade-in Allowance (TIA) – amount allowed
for old equipment toward the purchase price of
similar new assets.
 Boot – balance owed on new equipment after
trade-in allowance has been deducted.
 TIA > Book Value = Gain on Trade
 TIA < Book Value = Loss on Trade
 Gains are never recognized (not recorded).
 Losses must be recognized (recorded).
Exchanges
Exchanges of
of Similar
Similar Fixed
Fixed Assets
Assets
List price of new equipment acquired $5,000
Cost of old equipment traded in $4,000
Accum. depreciation at date of exchange 3,200
Book value at date of exchange $ 800

CASE ONE (GAIN):


Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100) Gains
Gains are
are not
not
TIA > Book Value = Gain recognized
recognized for
for
$1,100 – $800 = $300 financial
financial reporting.
reporting.
Boot + Book = Cost of New Equipment
$3,900 + $800 = $4,700
Exchanges
Exchanges of
of Similar
Similar Fixed
Fixed Assets
Assets

On June 19, equipment exchanged


at a gain of $300.
June 19 Accumulated Depr.—Equipment 3 200 00
Equipment (new equipment) 4 700 00
Equipment (old equipment) 4 000 00
Cash 3 900 00
Exchanges
Exchanges of
of Similar
Similar Fixed
Fixed Assets
Assets
List price of new equipment acquired $10,000
Cost of old equipment traded in $7,000
Accum. depreciation at date of exchange 4,600
Book value at date of exchange $2,400

CASE TWO (LOSS):


Trade-in allowance, $2,000
Cash paid, $8,000 ($10,000 – $2,000)
TIA<Book Value = Loss Losses
Losses are
are
$2,000 – $2,400 = $400 recognized
recognized for
for
financial
financial reporting.
reporting.
Exchanges
Exchanges of
of Similar
Similar Fixed
Fixed Assets
Assets

On September 7, equipment
exchanged at a loss of $400.
Sept. 7 Accumulated Depr.—Equipment 4 600 00
Equipment (new equipment) 10 000 00
Loss on Disposal of Fixed Assets 400 00
Equipment (old equipment) 7 000 00
Cash 8 000 00
Natural
Natural Resources
Resources and
and
Depletion
Depletion
Depletion
Depletion isis the
the process
process of
of
transferring
transferring the
the cost
cost of
of natural
natural
resources
resources toto an
an expense
expense account.
account.
Natural
Natural Resources
Resources and
and Depletion
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).
Natural
Natural Resources
Resources and
and Depletion
Depletion
During the current year, 90,000 tons are
mined. The periodic depletion is
$36,000 (90,000 tons x $0.40).

Adjusting Entry
Dec. 31 Depletion Expense 36 000 00
Accumulated Depletion 36 000 00
Intangible Assets and Amortization
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).

Date Description Debit Credit


Dec. 31 Amortization Expense 20,000
Patents 20,000

Paid $100,000 for patent rights. The patent life is 11


years and was issued 6 years prior to purchase.
11 years – 6 years = 5-year life
($100,000 / 5 years) = $20,000 per year
Discovery Mining Co.
Partial Balance Sheet
December 31, 2006
Accum. Book
Property, plant, and equipment: Cost Depr. Value
Land $ 30,000 $ 30,000
Buildings 110,000 $ 26,000 84,000
Factory equipment 650,000 192,000 458,000
Office equipment 120,000 13,000 107,000
$910,000 $231,000 $ 679,000
Accum. Book
Mineral deposits: Cost Depr. 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 $1,629,000
Intangible assets:
Patents $ 75,000
Goodwill 50,000
Total intangible assets $ 125,000
Ratio of Fixed Assets to Long-Term
Liabilities (in millions)
Procter & Gamble
2002 2001
Fixed assets (net) $13,349 $13,095
Long-term debt $11,201 $9,792
Ratio of fixed assets to
long-term liabilities 1.2 1.3
Use:
Use: To
To indicate
indicate the
the margin
margin of
of safety
safety
to
to long-term
long-termcreditors
creditors
Chapter 10

The
The End
End