Intangible Assets Operating Assets • Used in the day to day operations of a business to generate income for many years • They cost large amounts of money • Categories: – Fixed Assets – physical form – Natural Resources – Intangible Assets – no physical form Fixed Assets • Common types – Land – Land Improvements – Buildings – Machinery and equipment – Furniture and fixtures – Automobiles • If used in the business, they are set up as fixed assets. • If not used in the business and we are just holding them for later use or sale, they are investments. Determining the Cost of Operating Assets • Purchase price plus – Additional expenditures to get the asset ready for use – Examples: back property taxes, tearing down old buildings, closing costs, sales taxes, delivery costs, building permits, architect’s fees, additional dirt Additional Expenditures Capitalization versus Expense • Capitalization (Record as asset) – If the additional cost extends the life of the asset OR – Adds new long-lasting value to the asset • Expense – Routine maintenance – Does not extend the life of the asset Leasing Fixed Assets • Lessor – owner of the property • Lessee – user of the property • If long-term, set up the lease as a capital lease. – Lease is an asset – Payments due are a liability • If short-term, expense the lease. Depreciation • Cost allocation, NOT MARKET VALUATION • Causes of depreciation – Wear and tear – Use – Time passage • Measuring depreciation – Cost – Estimated useful life (how long the asset is intended to be used in the business) – Estimated residual (salvage) value (what you can sell the asset for when the useful life is over) – Book value • DOES NOT REPRESENT MARKET VALUE!!!!!!!! • Cost – accumulated depreciation Depreciation Methods • Straight line (equal amount of depreciation each year) • Units-of-production (depreciation based on how many units made or used up that year) • Double-declining (Accelerated method where more depreciation is taken in the early years) Straight-line • Cost $20,000, Residual value $4,000, Useful life 5 years • Cost – residual value = $20,000 – 4,000 • Useful life 5 years • $3,200 each year • Depr. Expense Accum. Depr. Book Value • 1 – 3,200 3,200 16,800 • 2 – 3,200 6,400 13,600 • 3 – 3,200 9,600 10,400 • 4 – 3,200 12,800 7,200 • 5 – 3,200 16,000 4,000 Units-of-production • Cost $20,000, Residual value $4,000, Useful life 100,000 units of product • Cost – residual value = $20,000 – 4,000 • Useful production 100,000 • $.16 per unit, Years 1-3 25,000 units, 4 – 15,000, 5 - 10,000 • Depr. Expense Accum. Depr. Book Value • 1 – 4,000 4,000 16,000 • 2 – 4,000 8,000 12,000 • 3 – 4,000 12,000 8,000 • 4 – 2,400 14,400 5,600 • 5 – 1,600 16,000 4,000 Double-Declining Balance • Cost $20,000, Residual value $4,000, Useful life 5 years • 100%/5 years = 20% x 2 = 40% per year (Switch to straight line in year 4) • Year 1 – Book value x 40% • Depr. Expense Accum. Depr. Book Value • 1 – 8,000 8,000 12,000 • 2 – 4,800 12,800 7,200 • 3 – 2,880 15,680 4,320 • 4 – 160 15,840 4,160 • 5 – 160 16,000 4,000 Comparison of Methods Units-of Double-Decl. • Straight-line Production Balance • 1- 3,200 4,000 8,000 • 2- 3,200 4,000 4,800 • 3- 3,200 4,000 2,880 • 4- 3,200 2,400 160 • 5- 3,200 1,600 160 Depreciation Methods • Income tax depreciation – MACRS (Modified Accelerated Cost Recovery System) – based on double-declining method • Partial years – when purchasing the asset on a day other than January 1, a portion of the annual depreciation should be taken – Purchase 1-15 day of month (take whole month) – Purchase 16-31 day of month (wait until next month for depreciation) • Revision of depreciation estimates – Depreciate book value using new useful life Disposal of Plant Assets • Can retire, junk, sale or trade in asset • Procedure – 1 – Record depreciation through date of disposal – 2 – Remove related accumulated depreciation amount from books by debiting that account – 3 – Determine the book value (Cost – accumulated depreciation) – 4 – Determine the gain or loss Disposal of Plant Assets • Example: Sold equipment costing $10,000 with Accum. Depr. of $7,000 for $5,000. (Depreciation up to date) • Sales price $5,000 – book value (10,000 – 7,000) $3,000 = $2,000 gain • Entry: • Cash 5,000 • Accumulated Depreciation 7,000 • Equipment (cost) 10,000 • Gain on sale of asset 2,000 Disposal of Plant Assets • Exchanging Plant Assets for new plant assets • Instead of selling the asset in the previous example, assume we traded it in with $10,000 cash. • Journal entry: • New equipment $13,000 • (10,000 + 3,000 b.v. of old) • Accum. Depreciation 7,000 • Old equipment 10,000 • Cash 10,000 • Gain goes into the cost of the new equipment. • Loss must be expensed right away and the new equipment will be the list price. Natural Resources • Examples: Iron ore, oil, timber, metals • Set up purchase price plus costs to get ready to extract as asset • Use similar to depreciation is recorded as “depletion expense” • Depletion expense method is similar to units-of-production depreciation method Intangible Assets • Characteristics – no physical form, these assets give you rights and privileges • Examples: patents, copyrights, trademarks, brand names, franchises, licenses, goodwill • Set up purchase price as asset • Use is similar to depreciation and is recorded as “amortization expense” • Amortization expense is like straight-line deprecation • Goodwill and trademarks are not amortized but tested for impairment losses occassionally. Financial Analysis and Interpretation • Fixed Asset Turnover Ratio: