Power Notes Chapter 10 Fixed Assets Learning Objectives 1. Nature of Fixed Assets 2. Accounting for Depreciation 3. Capital and Revenue Expenditures 4. Disposal of Fixed Assets C10

Nature of Fixed Assets Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues. ASSETS LIABILITIES OWNER’S EQUITY Fixed Assets REVENUES EXPENSES

Nature of Fixed Assets Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues. ASSETS LIABILITIES OWNER’S EQUITY Fixed Assets All fixed assets except land lose their capacity to provide services. This loss of productive capacity is recognized as depreciation expense. REVENUES EXPENSES

Costs of Acquiring Fixed Assets Include: Sales tax and freight costs Installation and assembling Repairs and reconditioning (used assets) Testing and modifying Insurance while asset is in transit

Costs of Acquiring Fixed Assets Exclude: Vandalism and uninsured theft Mistakes in installation Damage during unpacking and installing

Factors that Determine Depreciation Expense Initial Cost $24,000 a minus

Factors that Determine Depreciation Expense Initial Cost $24,000 a minus b Estimated Residual Value $2,000 equals

Factors that Determine Depreciation Expense Initial Cost $24,000 a minus b Estimated Residual Value $2,000 equals Depreciable Cost $22,000 divided by

Factors that Determine Depreciation Expense Initial Cost $24,000 a minus b Estimated Residual Value $2,000 equals Depreciable Cost $22,000 divided by c Estimated Useful Life 5 years equals

Factors that Determine Depreciation Expense Initial Cost $24,000 minus b Estimated Residual Value $2,000 equals Depreciable Cost $22,000 divided by c Estimated Useful Life 5 years equals Periodic Depreciation Expense $4,400 per year

Recording Depreciation Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years. A B Record straight-line depreciation for first year. General Ledger General Journal Equipment Description Debit Credit A 24,000 Equipment 24,000 Cash 24,000 A Accum. Depreciation B Depreciation Expense

Recording Depreciation Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years. A B Record straight-line depreciation for first year. General Ledger General Journal Equipment Description Debit Credit A 24,000 Equipment 24,000 Cash 24,000 Depreciation Expense 4,400 Accum. Depreciation 4,400 A Accum. Depreciation B Depreciation Expense

Recording Depreciation Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years. A B Record straight-line depreciation for first year. General Ledger General Journal Equipment Description Debit Credit A 24,000 Equipment 24,000 Cash 24,000 Depreciation Expense 4,400 Accum. Depreciation 4,400 A Accum. Depreciation B Depreciation Expense $24,000 - $2,000 5 years = $4,400

Recording Depreciation Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years. A B Record straight-line depreciation for first year. General Ledger General Journal Equipment Description Debit Credit A 24,000 Equipment 24,000 Cash 24,000 Depreciation Expense 4,400 Accum. Depreciation 4,400 A Accum. Depreciation B 4,400 B Depreciation Expense B $24,000 - $2,000 5 years 4,400 = $4,400

Calculation of Book Value General Ledger Equipment A 24,000 Accum. Depreciation 4,400 B Depreciation Expense B 4,400

Calculation of Book Value General Ledger Equipment A Original Cost $24,000 Less Accum. Depr. 4,400 Book Value 19,600 24,000 Accum. Depreciation 4,400 B Depreciation Expense B 4,400

Depreciation Methods The following four depreciation methods are acceptable for Financial Accounting purposes: 1. Straight-Line 2. Units-of-Production 3. Declining-Balance 4. Sum-of-Years-Digits Straight-line is far more widely used than other methods. Declining-balance and sum-of-years-digits are known as accelerated depreciation methods.

Comparing Depreciation Methods Straight-Line Method Declining-Balance Method 10,000 8,000 6,000 4,000 2,000 Depreciation ($) Life (years) Life (years)

Straight - Line Depreciation 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 $24,000.00 $4,400.00 $19,600.00 2 24,000 $ 4,400.00 19,600.00 4,400.00 15,200.00 3 24,000 8,800.00 15,200.00 4,400.00 10,800.00 4 24,000 13,200.00 10,800.00 4,400.00 6,400.00 5 24,000 17,600.00 6,400.00 4,400.00 2,000.00 Cost ($24,000) - Residual Value ($2,000) Annual Depreciation Expense ($4,400) = Estimated Useful Life (5 years)

Declining - Balance Depreciation Accum. Depr. Book Value Depr. Book Value at Beginning at Beginning Expense at End Year Cost of Year of Year Rate for Year of Year 1 $24,000 $24,000.00 40% $9,600.00 $14,400.00 2 24,000 $ 9,600.00 14,400.00 40% 5,760.00 8,640.00 3 24,000 15,360.00 8,640.00 40% 3,456.00 5,184.00 4 24,000 18,816.00 5,184.00 40% 2,073.60 3,110.40 5 24,000 20,889.60 3,110.40 –– 1,110.40 2,000.00 Note the acceleration of depreciation expense into early years of the life of the asset.

Capital and Revenue Expenditures Increases operating efficiency or adds to capacity? Yes Capital Expenditure (Debit fixed asset account)

Capital and Revenue Expenditures Increases operating efficiency or adds to capacity? Increases useful life (extraordinary repairs)? No Yes Capital Expenditure (Debit fixed asset account)

Capital and Revenue Expenditures Increases operating efficiency or adds to capacity? Increases useful life (extraordinary repairs)? No Yes Yes Capital Expenditure (Debit accumulated depreciation account) Capital Expenditure (Debit fixed asset account)

Capital and Revenue Expenditures Revenue Expenditure (Debit expense account for ordinary maintenance and repairs) Increases operating efficiency or adds to capacity? Increases useful life (extraordinary repairs)? No No Yes Yes Capital Expenditure (Debit accumulated depreciation account) Capital Expenditure (Debit fixed asset account)

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

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

Accounting for Fixed Asset 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: Asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove its balance from the ledger.

Discarding Fixed Assets Date Description Debit Credit Accumulated Depreciation 25,000 Equipment 25,000 Loss on Disposal of Equipment 1,100 Accumulated Depreciation 4,900 Equipment 6,000 Feb. 14 Write off fully depreciated equipment. Mar. 24 Write off partially depreciated equipment.

Sale of Fixed 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 of Fixed Assets Sold equipment with a book value of $2,250 (cost $10,000, accumulated depreciation $7,750). Date Description Debit Credit Cash 1,000 Loss on Disposal of Equipment 1,250 Accumulated Depreciation 7,750 Equipment 10,000 Cash 2,800 Gain on Disposal of Equipment 550 Oct. 12 Sold below book value, for $1,000. Oct. 12 Sold above book value, for $2,800.

Exchanges of Similar Fixed 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 of Similar Fixed Assets Quoted price of new equipment acquired $15,000 Cost of old equipment traded in $12,500 Accum. depreciation at date of exchange 10,100 Book value at date of exchange $ 2,400 Case One (GAIN) Trade-in allowance, $3,000 Cash paid, $12,000 ($15,000 – $3,000) TIA > Book Value = Gain $3,000 – $2,400 = $600 Boot + Book = Cost of New Equipment $12,000 + $2,400 = $14,400 Gains are not recognized for financial reporting.

Exchanges of Similar Fixed Assets Quoted price of new equipment acquired $15,000 Cost of old equipment traded in $12,500 Accum. depreciation at date of exchange 10,100 Book value at date of exchange $ 2,400 Case Two (LOSS) Trade-in allowance, $2,000 Cash paid, $13,000 ($15,000 – $2,000) TIA < Book Value = Loss $2,000 – $2,400 = $400 Cost of New Equipment = Quoted Price of New Asset $15,000 Losses are recognized for financial reporting.