Presentation on theme: "By Rachelle Agatha, CPA, MBA"— Presentation transcript:
1 By Rachelle Agatha, CPA, MBA Fixed AssetsBy Rachelle Agatha, CPA, MBASlides by Rachelle Agatha, CPA,with excerpts from Warren, Reeve, Duchac
2 Objectives:Define, classify, and account for the cost of fixed assets.Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method.
3 Objectives:Journalize entries for the disposal of fixed assets.Compute depletion and journalize the entry for depletion.Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.
4 Objectives:Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.
5 Define, classify, and account for the cost of fixed assets. Objective 1Define, classify, and account for the cost of fixed assets.
6 Nature of Fixed AssetsFixed 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 asset used in a productive purpose? Classifying CostsIs the purchased item long-lived?yesnoIs the asset used in a productive purpose?ExpenseyesnoFixed AssetsInvestment
9 Permits from government agencies Broker’s commissions Title fees Cost of Acquiring Fixed AssetsLANDPurchase priceSales taxesPermits from government agenciesBroker’s commissionsTitle feesSurveying feesDelinquent real estate taxesRazing or removing unwanted buildings, less any salvageGrading and levelingPaving a public street bordering the land
10 Insurance costs incurred during construction Cost of Acquiring Fixed AssetsBUILDINGArchitects’ feesEngineers’ feesInsurance costs incurred during constructionInterest on money borrowed to finance constructionWalkways to and around the buildingSales taxesRepairs (purchase of existing building)Reconditioning (purchase of existing building)Modifying for usePermits from government agencies
11 MACHINERY AND EQUIPMENT Cost of Acquiring Fixed AssetsMACHINERY AND EQUIPMENTModification for userTesting for usePermits from government agenciesSales taxesFreightInstallationRepairs (purchase of used equipment)Reconditioning (purchase of used equipment)Insurance while in transitAssemblyLAND IMPROVEMENTTrees and shrubsFencesOutdoor lightingPaved parking areas
12 Mistakes in installation Uninsured theft Cost of Acquiring Fixed Assets Excludes:VandalismMistakes in installationUninsured theftDamage during unpacking and installingFines for not obtaining proper permits from government agencies
13 Capital and Revenue ExpendituresExpenditures that benefit only the current period are called revenue expenditures. Expenditures that improve the asset or extend its useful life are capital expenditures.
14 Normal and ordinary repairs and maintenance REVENUE EXPENDITURESCAPITAL EXPENDITURESAdditionsImprovementsExtraordinaryrepairsNormal and ordinary repairs and maintenanceOperating Expenses
15 This is a revenue expenditure/operating exp Ordinary Maintenance and RepairsOn April 9, the firm paid $300 for a tune-up of a delivery truck.Apr. 9 Repairs and Maintenance ExpCashThis is a revenue expenditure/operating exp
16 This is a capital expenditure Asset ImprovementsOn 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 TruckCashThis is a capital expenditure
17 This is a capital expenditure Extraordinary RepairsThe 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—ForkliftCashThis is a capital 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.June 18 Delivery Truck 1,200Cash 1,20018 Repairs and Maintenance Exp. 45Cash 4519
20 Leasing Fixed AssetsA 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 AssetsA 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 Objective 2Compute depreciation using the following methods: straight-line method, units-of-production method, double-declining-balance method.
23 Accounting for DepreciationOver 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.
24 Physical and Functional DepreciationPhysical 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.
25 Factors in Computing DepreciationThe 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 Residual ValueThe 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.
28 Exhibit 5: Use of Depreciation Methods Exhibit 5: Use of Depreciation MethodsStraight-lineUnits-of-productionDouble-declining-balanceOtherSource: Accounting Trends & Techniques, 59th ed., American Institute of Certified Public Accountants, New York, 2005.
29 Cost – est residual value Estimated life Straight-Line MethodThe 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 lifeAnnual depreciation =$24,000 – $2,0005 yearsAnnual 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.$120,000 ($125,000 – $5,000)10% = (1/10)$12,000 ($120,000 x 10%) or ($120,000 ÷ 10 years)
33 Cost – estimated residual value Estimated hours, units, etc. Units-of-Production MethodThe 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 =Cost – estimated residual valueEstimated hoursHourly depreciation =$24,000 – $2,00010,000 estimated hoursHourly depreciation =$2.20 hourly depreciation
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.$170,000 ($180,000 – $10,000)$4.25 per hour ($170,000/40,000 hours)$15,300 (3,600 hours x $4.25)
37 Double-Declining-Balance MethodThe 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 Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $24,000 40% $9,600$24,000 x .40
41 Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $24,000 40% $9,600 $9,600 $14,4002 14,400 40% 5,760$14,400 x .40
42 Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $24,000 40% $9,600 $9,600 $14,4002 14,400 40% 5,760 15,360 8,640
43 Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $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 Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $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 DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE! Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $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 1,866STOPDEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE!
46 “Forced” annual depreciation Desired ending book value Book Value Accum.Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End1 $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 – $2,000 1,110 22,000 2,000“Forced” annual depreciationDesired ending book value
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.$120,000 ($125,000 – $5,000)20% [(1/10) x2]$25,000 ($125,000 x 20%)
50 Depreciation for Federal Income TaxThe 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 Annual Depreciation (S/L) Revising Depreciation EstimatesA 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.$140,000 – $10,0005 yearsAnnual 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) 52,000Book 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 $80,000Revised 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.
57 Journalize entries for the disposal of fixed assets. Objective 3Journalize entries for the disposal of fixed assets.
58 Discarding Fixed AssetsA piece of equipment acquired at a cost of $25,000 is fully depreciation. On February 14, the equipment is discarded.Feb. 14 Accumulated Depr.—EquipmentEquipmentTo 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—EquipmentAccum. Depr.—Equipment$600 x 3/12To record current depreciation on equipment discarded.
60 The discarding of the equipment is then recorded by the following entry:Mar. 24 Accum. Depreciation—EquipmentLoss on Disposal of Fixed AssetsEquipmentTo write off equipment discarded.
61 Selling Fixed AssetsEquipment 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.Oct. 12 Depreciation Expense—EquipmentAccum. Depr.—Equipment$10,000 x ¾ x10%To record current depreciation on equipment sold.
62 The equipment is sold on October 12 for $2,250. No gain or loss. Assumption 1The equipment is sold on October 12 for $2,250. No gain or loss.Oct. 12 CashAccum. Depreciation—EquipmentEquipmentSold equipment at book value.
63 The equipment is sold on October 12 for $1,000; a loss of $1,250. Assumption 2The equipment is sold on October 12 for $1,000; a loss of $1,250.Oct. 12 CashAccum. Depreciation—EquipmentLoss on Disposal of Fixed AssetsEquipmentSold equipment at a loss.
64 The equipment is sold on October 12 for $2,800; a gain of $550. Assumption 3The equipment is sold on October 12 for $2,800; a gain of $550.Oct. 12 CashAccum. Depreciation—EquipmentEquipmentGain on Disp. of Fixed AssetsSold equipment at a gain.
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.What was the depreciation for the first year?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.Journalize the entry to record the sale.
66 $9,000 [($91,000 – $10,000)/9]$5,000 gain; $78,000 – [$91,000 – ($9,000 x 2)]Cash ,000Accum. Depreciation—Equipment 18,000Equipment ,000Gain on Disposal of Fixed Assets ,000
67 Exchanging Fixed AssetsWhen 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 IMPORTANT!Gains on exchanges of similar fixed assets are not recognized for financial reporting purposes.
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 List price of new equipment $5,000 Trade-in allowance $1,100 Two Methods of Determining CostMethod OneList price of new equipment $5,000Trade-in allowance $1,100Book value of old equipmentUnrecognized gain on exchange (300)Cost of new equipment $4,700
71 Book value of old equipment $ 800 Cash paid at date of exchange 3,900 Method TwoBook value of old equipment $ 800Cash paid at date of exchange 3,900Cost of new equipment $4,700Note that either method provides the same cost for the new equipment.
72 On June 19, equipment was exchanged at a gain of $300. On June 19, equipment was exchanged at a gain of $300.June 19 Accum. Depreciation—EquipmentEquipment (new equipment)Equipment (old equipment)CashTo record exchange of equipment.
73 Losses on ExchangesFor 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 $ 400Sept 7 Accum. Depreciation—EquipmentEquipmentLoss on Disposal of Fixed AssetsEquipmentCashTo 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.Determine the cost of the new truck for financial reporting purposes.Journalize the entry to record the exchange.
76 List price of new truck $75,000 Trade-in allowance on old truck $73,500List 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) ,500Unrecognized gain on exchange ,500)Cost of new truck $73,500(Continued)or
77 Plus cash paid at date of exchange 63,000 Cost of new truck $73,500 Book value of old truck($50,000 – $39,5000) $10,500Plus cash paid at date of exchange 63,000Cost of new truck $73,500Truck (new) 73,500Accum Dep Truck (old) 39,500Truck (old) 50,000Cash 63,000
78 Compute depletion and journalize the entry for depletion. Objective 4Compute depletion and journalize the entry for depletion.
79 Natural ResourcesThe process of transferring the cost of natural resources to an expense account is called depletion.
80 Recording DepletionA 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 If 90,000 tons are mined during the year, an adjusting entry is required at the end of the accounting period.Adjusting EntryDec. 31 Depletion ExpenseAccumulated DepletionDepletion of mineral deposit.
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.Determine the depletion rate.Determine the amount of depletion expense for the current year.Journalize the adjusting entry on December 31 to recognize the depletion expense.
83 Depletion of mineral deposit. $0.90 per ton = $45,000,000/50,000,000 tons$11,340,000 – (12,600,000 tons x $0.90 per ton)Dec. 31 Depletion Expense 11,340,000AccumulatedDepletion 11,340,000Depletion of mineral deposit.
84 Objective 5Describe the accounting for intangible assets, such patents, copyrights, and goodwill.
85 Intangible AssetsPatents, 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 Journalizing Amortization of a PatentAt the beginning of its fiscal year, a business acquires a patent right for $100,000. Its remaining useful life is estimated at 5 years.Adjusting EntryDec. 31 Amortization Expense—PatentsPatentsPatent amortization ($100,000/5).
88 Dec. 31 Amortization Expense—PatentsPatentsPatent amortization ($100,000/5).Adjusting EntryBecause 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 CopyrightThe 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.
90 TrademarkA 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.
91 Goodwill10-5In 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.
92 Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction.
93 Impaired GoodwillA loss should be recorded if the business prospects of the acquired firm (and the acquired goodwill) become significantly impaired.Mar Loss from Impaired GoodwillGoodwillImpaired 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.Journalize the adjusting entry on December 31, for the impaired goodwill.Journalize the adjusting entry on December 31 for the amortization of the patent rights.
95 Dec. 31 Loss from Impaired Goodwill 40,000Goodwill 40,000Impaired goodwill.Dec. 31 Amortization Expense—Patents 3,500Patents 3,500Amortized patent rights[($84,000/12) x (6/12)].
96 Objective 6Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.
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.The fixed assets may be shown at their net amount.Office equipment $125,750Less accumulated depreciation ,300Net 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 RatioOne 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:Fixed Asset Turnover RatioRevenueAverage Book Value of Fixed Assets=
101 Fixed Asset Turnover Ratio Revenue Average Book Value of Fixed Assets Financial Analysis and InterpretationFor Marriott International, Inc. (in millions)Fixed Asset Turnover RatioRevenueAverage Book Value of Fixed Assets=Fixed Asset Turnover Ratio$11,550($2, ,389)/2=Fixed Asset Turnover Ratio=4.88Conclusion: For every dollar of fixed assets, Marriott earns $4.88 of revenue.
102 Summary Classification of Fixed Assets Depreciation Methods Journalize related entriesDepletionIntangiblesFinancial Statement presentation