1. 9-1 Fixed Assets and Intangible Assets Chapter 9 Electronic Presentation by Douglas Cloud Pepperdine University

2. 9-2 1.Define, classify, and account for the cost of fixed assets. 2.Compute depreciation, using the following methods: straight-line, units-of-production, and declining-balance. 3.Compute and record depletion of natural resources. 4.Account for the disposal of fixed assets. Learning Goals After studying this chapter, you should be able to: ContinuedContinued

3. 9-3 5.Classify fixed asset costs as either capital expenditures or revenue expenditures according to their project stage. 6.Analyze the utilization of fixed assets. 7.Describe and account for intangible assets, such as patents, copyrights, and goodwill. 8.Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. Learning Goals

4. 9-4 1 Learning Goal Define, classify, and account for the cost of fixed assets.

5. 9-5 Nature of Fixed Assets Fixed assets are long term or relatively permanent assets Fixed assets are tangible assets because they exist physically. They are owned and used by the business and are not held for sale as part of normal operations.

6. 9-6 Nature of Fixed Assets If the purchased item is long-lived, then it should be capitalized, which means an asset is debited for the expenditure rather than an expense.

7. 9-7 yes Fixed Assets no Is the purchased item long-lived? Is the asset used in a productive purpose? yes no Expense Investment

8. 9-8LandLand Purchase pricePurchase price Sales taxesSales taxes Permits from government agenciesPermits from government agencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees Purchase pricePurchase price Sales taxesSales taxes Permits from government agenciesPermits from government agencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees ContinuedContinued

9. 9-9 Purchase pricePurchase price Sales taxesSales taxes Permits from government agenciesPermits from government agencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees Purchase pricePurchase price Sales taxesSales taxes Permits from government agenciesPermits from government agencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees Delinquent real estate taxesDelinquent real estate taxes Razing or removing unwanted buildings, less the salvageRazing or removing unwanted buildings, less the salvage Grading and levelingGrading and leveling Paving a public street bordering the landPaving a public street bordering the land Delinquent real estate taxesDelinquent real estate taxes Razing or removing unwanted buildings, less the salvageRazing or removing unwanted buildings, less the salvage Grading and levelingGrading and leveling Paving a public street bordering the landPaving a public street bordering the land LandLand

10. 9-10 Buildings Architects’ fees Engineers’ fees Insurance costs incurred during construction Interest on money borrowed to finance construction Walkways to and around the building ContinuedContinued

11. 9-11 Sales taxes Repairs (purchase of existing building) Reconditioning (purchase of an existing building) Modifying for use Permits from governmental agencies Buildings

12. 9-12 Trees and shrubs Fences Parking areas Outdoor lighting Concrete sewers and drainage Paved parking areas Land Improvements

13. 9-13 Machinery and Equipment Sales taxes Freight Installation Repairs (purchase of used equipment) Reconditioning (purchase of used equipment) Continued

14. 9-14 Insurance while in transit Assembly Modifying for use Testing for use Permits from governmental agencies Machinery and Equipment

15. 9-15 Cost of Acquiring Fixed Assets Excludes:  Vandalism  Mistakes in installation  Uninsured theft  Damage during unpacking and installing  Fines for not obtaining proper permits from government agencies

16. 9-16 Compute depreciation, using the following methods: straight-line, units-of-production, and declining-balance. 2 Learning Goal

17. 9-17

18. 9-18 Use of Depreciation Methods Source: Accounting Trends & Techniques, 55 th. ed., American Institute of Certified Public Accountants, New York, 2002

19. 9-19DataData Original Cost.....………….. $24,000 Estimated Life in years…..5 years Estimated Life in hours….. 10,000 Estimated Residual Value...$2,000 Original Cost.....………….. $24,000 Estimated Life in years…..5 years Estimated Life in hours….. 10,000 Estimated Residual Value...$2,000

20. 9-20 Straight-Line Method Cost – estimated residual value Estimated life = Annual depreciation

21. 9-21 Straight-Line Method $24,000 – $2,000 5 years = $4,400 annual depreciation Dec. 31Depreciation Expense4,400 Accumulated Depreciation4,400

22. 9-22 Straight-Line Rate $24,000 – $2,000 5 years = $4,400 $4,400 $24,000 = 18.3%

23. 9-23 Straight-Line Method 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.

24. 9-24 Accum. Depr.Book ValueDepr.Book Value at Beginningat BeginningExpenseat End YearCostof Yearof Year for Yearof Year 1$24,000$24,000$4,400$19,600 224,000$ 4,40019,6004,40015,200 324,0008,800 15,200 4,400 10,800 424,00013,200 10,800 4,400 6,400 524,00017,6006,4004,4002,000 Straight-Line Method Cost ($24,000) – Residual Value ($2,000) Estimated Useful Life (5 years) = Annual Depreciation Expense ($4,400)

25. 9-25 Accum. Depr.Book ValueDepr.Book Value at Beginningat BeginningExpenseat End YearCostof Yearof Year for Yearof Year 1$24,000$24,000$4,400$19,600 224,000$ 4,40019,6004,40015,200 324,0008,800 15,200 4,400 10,800 424,00013,200 10,800 4,400 6,400 524,00017,6006,4004,4002,000 Ending book value equals the residual value Straight-Line Method

26. 9-26 Units-of-Production Basis Cost – estimated residual value Estimated life in hours. = Depreciation per hour

27. 9-27 $24,000 – $2,000 10,000 hours = Depreciation per hour= $2.20 per hour Units-of-Production Basis

28. 9-28 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. Units-of-Production Basis

29. 9-29 Declining-Balance Method Step 1 Ignoring residual value, determine the straight-line rate = $4,800 $24,000 - $2,000 5 years $4,800 $24,000 = 20%

30. 9-30 Declining-Balance Method = $4,800 $24,000 - $2,000 5 years $4,800 $24,000 = 20% Step 1 Ignoring residual value, determine the straight-line rate There’s a shortcut. Simply divide the number of years by one (1 ÷ 5 =.20).

31. 9-31 Declining-Balance Method Double the rate. Step 2.20 x 2 =.40 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 by 40 percent.

32. 9-32 Build a table. Step 3 Declining-Balance Method

33. 9-33 Accum. Depr. Book Value. Beginning at Beginning Depr. Book Value Year of Year Rate of Year for Year Year-End 140%$24,000.00$9,600.00$14,400.00 2$ 9,600.0040%14,400.005,760.008,640.00 315,360.0040%8,640.003,456.005,184.00 418,816.0040% 5,184.002,073.603,110.40 520,889.60---3,110.401,110.402,000.00 Declining-Balance Method $3,110.40 – $2,000.00 Desired ending book value

34. 9-34 Comparing Straight-Line With the Declining-Balance Method Straight-Line Method Depreciation ($) 5,000 4,000 3,000 2,000 1,000 0 Life (years) Declining-Balance Method Life (years)

35. 9-35 Revising Depreciation Estimates A fixed asset purchased for $130,000 was originally estimated to have a useful life of 10 years and a residual value of $10,000. The asset has been depreciated for five years using the straight-line method. Annual Depreciation $130,000 – $10,000 10 years $12,000 per year

36. 9-36 Equipment 130,000 Accumulated Depreciation 12,000 60,000 Before revising Book value = $70,000 Revising Depreciation Estimates

37. 9-37 During the sixth year, it is estimated that the remaining useful life is 9 years (instead of 5) and that the revised estimated residual value is $7,000. Book value – revised residual value Revised estimated remaining life $70,000 – $7,000 9 years = $7,000 Revising Depreciation Estimates

38. 9-38 Compute and record depletion of natural resources. 3 Learning Goal

39. 9-39 Natural Resources Depletion is the periodic transferring of the cost of natural resources, such as metal ores and other minerals removed from the earth, to an expense account.

40. 9-40 ($400,000 ÷ 1,000,000 tons) = $0.40 per ton 90,000 tons x $0.40 = $36,000 Paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore. During the year, 90,000 tons are mined. Dec. 31Depletion Expense36,000 Accumulated Depletion36,000 Natural Resources

41. 9-41 Account for the disposal of fixed assets. 4 Learning Goal

42. 9-42 Discarding Fixed Assets An item of equipment acquired at a cost of $25,000 is fully depreciated with no salvage value at December 31, 2004. On February 4, 2005, the equipment is discarded. Feb. 14Accumulated Depreciation25,000 Equipment25,000

43. 9-43 Mar. 24Depreciation Expense—Equipment150 Accumulated Depr.—Equipment150 Discarding Fixed Assets Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. The Accumulated Depreciation balance related to this equipment is $4,750. The asset is removed from service on March 24. Mar. 24Accumulated Depr.—Equipment4,900 Loss on Disposal of Fixed Assets1,100 Equipment6,000 $600 x 3/12 $4,750 + $150

44. 9-44 Selling Fixed Assets Oct. 12Depreciation Expense—Equipment750 Accumulated Depr.—Equipment750 Equipment is acquired at a cost of $10,000 and is depreciated at an annual straight-line rate of 10%. It is sold for $1,000 cash on October 12 of the eighth year of its use. The balance in Accumulated Depreciation is $7,000. Oct. 12Cash1,000 Accumulated Depr.—Equipment7,750 Loss on Disposal of Fixed Assets1,250 Equipment10,000 $1,000 x 9/12 $7,000 + $750

45. 9-45 5 Learning Goal Classify fixed assets as either capital expenditures or revenue expenditures according to their project stage.

46. 9-46 Expenditures to repair or maintain plant assets that do not extend the life or enhance the value are known as revenue expenditures. Capital and Revenue Expenditures

47. 9-47 Expenditures made for acquiring, constructing, adding, or replacing fixed assets are known as capital expenditures. Capital and Revenue Expenditures

48. 9-48 Increases operating efficiency or adds to capacity? Capital Expenditure (Debit fixed asset account) Yes Capital and Revenue Expenditures Increases useful life (extraordinary repairs)? No Capital Expenditure (Debit Accumulated Depreciation account) Yes Revenue Expenditure (Debit expense account for ordinary maintenance and repairs) No EXPENDITURE

49. 9-49 LIABILITIES OWNER’S EQUITY REVENUES ASSETS EXPENSES CAPITAL EXPENDITURES 1. Initial cost 2.Additions 3. Betterments 4. Extraordinary repairs 1. Initial cost 2.Additions 3. Betterments 4. Extraordinary repairs net income Capital and Revenue Expenditures

50. 9-50 Capital and Revenue Expenditures LIABILITIES OWNER’S EQUITY REVENUES ASSETS EXPENSES net income Normal and ordinary repairs and maintenance REVENUE EXPENDITURES

51. 9-51 Analyze the utilization of fixed assets. 6 Learning Goal

52. 9-52 Operational Utilization Analysis Annual usage of the fixed asset Total annual fixed asset capacity The closer the operational utilization approaches 100 percent, the more efficient the fixed assets.

53. 9-53 Financial Utilization Analysis Total Revenues Number of fixed asset units Use this ratio only when there is a correlation between the number of fixed asset units and total revenues. Revenue per Unit of Fixed Assets

54. 9-54 Financial Utilization Analysis Revenue Average book value of fixed assets The larger the ratio, the more efficiently a business is using its fixed assets. Fixed Asset Turnover Ratio

55. 9-55 Describe and account for intangible assets, such as patents, copyrights, and goodwill. 7 Learning Goal

56. 9-56PatentsPatents ? ? Patent Office The exclusive right granted by the federal government to produce and sell goods with one or more unique features is a patent.

57. 9-57PatentsPatents Maximum life20 years Costs:  Initial cost of purchased patent  Any related legal fees The straight-line method normally is used to amortize patents.

58. 9-58PatentsPatents A business acquires patent rights for $100,000. The patent had been granted 6 years earlier by the Federal Patent Office. The remaining useful life is estimated at 5 years. Dec. 31Amortization Expense—Patents20,000 Patents20,000$100,0005$100,0005

59. 9-59 Copyrights and Trademarks The exclusive right to publish and sell a literary, artistic, or musical composition is granted by a copyright. A copyright has a maximum life of 70 years beyond the death of the author.

60. 9-60 Copyrights and Trademarks A trademark is a name, term, or symbol used to identify a business and its products.

61. 9-61GoodwillGoodwill Goodwill refers to an intangible asset of the business that is created from such favorable factors as location, production quality, reputation, and managerial skills.

62. 9-62 Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. 8 Learning Goal

63. 9-63 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$125,000 Discovery Mining Co. Partial Balance Sheet December 31, 2005 Accum.Book Property, plant, and equipment: CostDepr.Value Land$ 30,000$ 30,000 Buildings110,000$ 26,00084,000 Factory equipment650,000192,000458,000 Office equipment 120,000 13,000107,000 $910,000$231,000$ 679,000 Accum.Book Mineral deposits:CostDepr.Value

64. 9-64 Parker Company Partial Income Statement for the Year Ended December 31, 2005 Operating Expenses: Delivery expense$ 18,000 Advertising expense33,000 Sales salaries expense41,000 Office salaries expense37,000 Administrative salaries69,000 Depreciation expense28,000 Taxes and insurance expense 22,000 Total operating expenses$248,000

65. 9-65 Alert Company Partial Statement of Cash Flows—Operating Activities for the Year Ended December 31, 2005 Operating Activities: Net income$8,400 Adjustments to reconcile net income to cash generated by operating activities: Depreciation and amortization3,400 Decrease in accounts receivable800 Increase in salaries payable400 Increase in inventory(1,600) Gain on sale of equipment (600) Net cash provided by operating activities$10,800

66. 9-66 Alert Company Partial Statement of Cash Flows—Investing Activities for the Year Ended December 31, 2005 Investing Activities: Purchase of short-term investments$14,000 Proceeds from the sale of equipment2,100 Payment for purchase of equipment(15,200) Purchase of long-term investments (6,000) Cash used for investing activities$(5,100)

67. 9-67 The End Chapter 9

68. 9-68