ACTG 2110 Chapter 10 – Fixed Assets and 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 life5 years $3,200 each year Depr. ExpenseAccum. Depr.Book Value 1 – 3,200 3,20016,800 2 – 3,200 6,40013,600 3 – 3,200 9,60010,400 4 – 3,20012,800 7,200 5 – 3,20016,000 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 production100,000 $.16 per unit, Years ,000 units, 4 – 15,000, ,000 Depr. ExpenseAccum. Depr.Book Value 1 – 4,000 4,00016,000 2 – 4,000 8,00012,000 3 – 4,000 12,000 8,000 4 – 2,40014,400 5,600 5 – 1,60016,000 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. ExpenseAccum. Depr.Book Value 1 – 8,000 8,00012,000 2 – 4,80012,800 7,200 3 – 2,880 15,680 4,320 4 – 16015,840 4,160 5 – 16016,000 4,000

Comparison of Methods Units-ofDouble-Decl. Straight-lineProductionBalance 1- 3,2004,0008, ,2004,0004, ,2004,0002, ,2002, ,2001,

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 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: Cash5,000 Accumulated Depreciation7,000 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 b.v. of old) Accum. Depreciation 7,000 Old equipment10,000 Cash10,000 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: Revenue Average book value of fixed assets Higher the turnover, the better