Click to edit Master title style Fixed Assets and Intangible Assets

Click to edit Master title style Define, classify, and account for the cost of fixed assets. 2. Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method. After studying this chapter, you should be able to:

Click to edit Master title style Journalize entries for the disposal of fixed assets. 4. Compute depletion and journalize the entry for depletion. 5. Describe the accounting for intangible assets, such as patents, copyrights, and goodwill. After studying this chapter, you should be able to:

Click to edit Master title style Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. After studying this chapter, you should be able to:

Click to edit Master title style Define, classify, and account for the cost of fixed assets. Objective

Click to edit Master title style Nature of Fixed Assets Fixed 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. 10-1

Click to edit Master title style Fixed Assets as a Percent of Total Assets— Selected Companies 10-1 Fixed Assets as a Percent of Total Assets—Selected Companies

Click to edit Master title style Is the purchased item long-lived? yes Is the asset used in a productive purpose? no Expense yes Fixed Assets no Investment Classifying Costs 10-1

Click to edit Master title style  Purchase price  Sales taxes  Permits from government agencies  Broker’s commissions  Title fees  Surveying fees  Delinquent real estate taxes  Razing or removing unwanted buildings, less any salvage  Grading and leveling  Paving a public street bordering the land LAND Cost of Acquiring Fixed Assets 10-1

Click to edit Master title style 10  Architects’ fees  Engineers’ fees  Insurance costs incurred during construction  Interest on money borrowed to finance construction  Walkways to and around the building  Sales taxes  Repairs (purchase of existing building)  Reconditioning (purchase of existing building)  Modifying for use  Permits from government agencies BUILDING Cost of Acquiring Fixed Assets 10-1

Click to edit Master title style 11  Sales taxes  Freight  Installation  Repairs (purchase of used equipment)  Reconditioning (purchase of used equipment)  Insurance while in transit  Assembly  Trees and shrubs  Fences  Outdoor lighting  Paved parking areas Cost of Acquiring Fixed Assets MACHINERY AND EQUIPMENT LAND IMPROVEMENT  Modification for user  Testing for use  Permits from government agencies 10-1

Click to edit Master title style 12 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 10-1

Click to edit Master title style 13 Expenditures that benefit only the current period are called revenue expenditures. Expenditures that improve the asset or extend its useful life are capital expenditures. Capital and Revenue Expenditures 10-1

Click to edit Master title style 14 CAPITAL EXPENDITURES 1) Additions 2) Improvements 3) Extraordinary repairs Normal and ordinary repairs and maintenance REVENUE EXPENDITURES 10-1

Click to edit Master title style 15 Ordinary Maintenance and Repairs On April 9, the firm paid $300 for a tune-up of a delivery truck. Apr. 9Repairs and Maintenance Exp Cash This is a revenue expenditure

Click to edit Master title style 16 Asset Improvements On 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 Truck Cash This is a capital expenditure

Click to edit Master title style 17 Extraordinary Repairs The 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. 14Accum. Depreciation—Forklift Cash This is a capital expenditure

Click to edit Master title style Capital or Revenue Expenditure

Click to edit Master title style Example Exercise 10-1 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. 19 Follow My Example 10-1 June 18Delivery Truck1,200 Cash1,200 18Repairs and Maintenance Exp.45 Cash45 For Practice: PE 10-1A, PE 10-1B

Click to edit Master title style 20 Leasing Fixed Assets A 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. 10-1

Click to edit Master title style 21 Leasing Fixed Assets A 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). 10-1

Click to edit Master title style 22 Compute depreciation using the following methods: straight-line method, units-of-production method, double-declining-balance method. Objective

Click to edit Master title style 23 Over 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 Accounting for Depreciation

Click to edit Master title style 24 Physical 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 Physical and Functional Depreciation

Click to edit Master title style 25 Factors in Computing Depreciation The 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. 10-2

Click to edit Master title style 26 The 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 Residual Value

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Click to edit Master title style 28 Source: Accounting Trends & Techniques, 59 th ed., American Institute of Certified Public Accountants, New York, Exhibit 5: Use of Depreciation Methods Straight-line Units-of-production Double-declining- balance Other 10-2

Click to edit Master title style 29 Straight-Line Method 10-2 The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life. Annual depreciation = Cost – estimated residual value Estimated life 29

Click to edit Master title style 30 A depreciable asset cost $24,000. Its estimated residual value is $2,000 and its estimated life is 5 years. Annual depreciation = Cost – estimated residual value Estimated life Annual depreciation = $24,000 – $2,000 5 years Annual depreciation =$4,

Click to edit Master title style 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. 10-2

Click to edit Master title style Example Exercise 10-2 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. 32 Follow My Example 10-2 (a)$120,000 ($125,000 – $5,000) (b)10% = (1/10) (c)$12,000 ($120,000 x 10%) or ($120,000 ÷ 10 years) For Practice: PE 10-2A, PE 10-2B

Click to edit Master title style 33 Units-of-Production Method The 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 value Estimated hours, units, etc.

Click to edit Master title style 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 = $24,000 – $2,000 10,000 estimated hours Hourly depreciation = $2.20 hourly depreciation Hourly depreciation = Cost – estimated residual value Estimated hours

Click to edit Master title style 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. 10-2

Click to edit Master title style Example Exercise 10-3 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. 36 Follow My Example 10-3 (a)$170,000 ($180,000 – $10,000) (b)$4.25 per hour ($170,000/40,000 hours) (c)$15,300 (3,600 hours x $4.25) For Practice: PE 10-3A, PE 10-3B

Click to edit Master title style 37 Double-Declining-Balance Method The double-declining- balance method provides for a declining periodic expense over the estimated useful life of the asset. 10-2

Click to edit Master title style 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). 10-2

Click to edit Master title style 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. 10-2

Click to edit Master title style 40 $24,000 x.40 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1$24,00040%$9,

Click to edit Master title style 41 1$24,00040%$9,600$9,600$14, ,40040%5,760 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End $14,400 x

Click to edit Master title style 42 1$24,00040%$9,600$9,600$14, ,40040%5,76015,3608,640 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 10-2

Click to edit Master title style 43 1$24,00040%$9,600$9,600$14, ,40040%5,76015,3608,640 38,64040%3,45618,8165,184 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 10-2

Click to edit Master title style 44 1$24,00040%$9,600$9,600$14, ,40040%5,76015,3608,640 38,64040%3,45618,8165,184 45,18440%2,07420,8903,110 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 10-2

Click to edit Master title style 45 1$24,00040%$9,600$9,600$14, ,40040%5,76015,3608,640 38,64040%3,45618,8165,184 45,18440%2,07420,8903,110 53,11040%1,24422,1341,866 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End STOP DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE! 10-2

Click to edit Master title style 46 1$24,00040%$9,600$9,600$14, ,40040%5,76015,3608,640 38,64040%3,45618,8165,184 45,18440%2,07420,8903,110 53,110 – $2,0001,11022,0002,000 Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End Desired ending book value “Forced” annual depreciation 10-2

Click to edit Master title style Example Exercise 10-4 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. 47 Follow My Example 10-4 (a)$120,000 ($125,000 – $5,000) (b)20% [(1/10) x2] (c)$25,000 ($125,000 x 20%) For Practice: PE 10-4A, PE 10-4B

Click to edit Master title style 48 Comparing Depreciation Methods 10-2

Click to edit Master title style Comparing Depreciation Methods

Click to edit Master title style 50 Depreciation for Federal Income Tax The Internal Revenue Code specifies the Modified Accelerated Cost Recovery System (MACRS) for use by businesses in computing depreciation for tax purposes. 10-2

Click to edit Master title style 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). 10-2

Click to edit Master title style 52 A 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. Revising Depreciation Estimates $140,000 – $10,000 5 years Annual Depreciation (S/L) = $26,000 per year Annual Depreciation (S/L) = 10-2

Click to edit Master title style 53 At the end of two years, the asset’s book value is $88,000, determined as follows: Asset cost$140,000 Less accumulated depreciation ($26,000 per year x 2 years) 52,000 Book value, end of second year$ 88,

Click to edit Master title style 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$88,000 Less revised estimated residual value 8,000 Revised remaining depreciation cost$80,000 Revised annual depreciation expense ($80,000 ÷ 8 years)$10,

Click to edit Master title style 55 Example Exercise 10-5 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 20 th year of use. (c) If at the start of the 21 st 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

Click to edit Master title style 56 For Practice: PE 10-5A, PE 10-5B 56 Follow My Example 10-5 a.$9,500 [($500,000 – $120,000)/40] b.$310,000 [$500,000 – ($9,500 x 20)] c.$6,400 [310,000 – $150,000)/25] 10-2

Click to edit Master title style 57 Journalize entries for the disposal of fixed assets. Objective

Click to edit Master title style 58 Discarding Fixed Assets A piece of equipment acquired at a cost of $25,000 is fully depreciation. On February 14, the equipment is discarded. Feb.14Accumulated Depr.—Equipment Equipment To write off equipment discarded

Click to edit Master title style 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.24Depreciation Expense—Equipment Accum. Depr.—Equipment To record current depreciation on equipment discarded. $600 x 3/

Click to edit Master title style 60 The discarding of the equipment is then recorded by the following entry: Mar.24Accum. Depreciation—Equipment Loss on Disposal of Fixed Assets Equipment To write off equipment discarded. 10-3

Click to edit Master title style 61 Equipment 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. Selling Fixed Assets Oct.12Depreciation Expense—Equipment Accum. Depr.—Equipment To record current depreciation on equipment sold. $10,000 x ¾ x10% 10-3

Click to edit Master title style 62 The equipment is sold on October 12 for $2,250. No gain or loss. Oct.12Cash Accum. Depreciation—Equipment Equipment Sold equipment at book value Assumption 1

Click to edit Master title style 63 Oct.12Cash Accum. Depreciation—Equipment Loss on Disposal of Fixed Assets Equipment Sold equipment at a loss. The equipment is sold on October 12 for $1,000; a loss of $1, Assumption 2

Click to edit Master title style 64 Oct.12Cash Accum. Depreciation—Equipment Equipment Sold equipment at a gain. The equipment is sold on October 12 for $2,800; a gain of $ Gain on Disp. of Fixed Assets Assumption 3

Click to edit Master title style Example Exercise 10-6 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, a.What was the depreciation for the first year? b.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. c.Journalize the entry to record the sale.

Click to edit Master title style 66 For Practice: PE 10-6A, PE 10-6B 66 Follow My Example 10-6 a.$ 9,000 [($91,000 – $10,000)/9] b.$5,000 gain; $78,000 – [$91,000 – ($9,000 x 2)] 10-3 c.Cash78,000 Accum. Depreciation—Equipment18,000 Equipment91,000 Gain on Disposal of Fixed Assets5,000

Click to edit Master title style 67 Exchanging Fixed Assets When 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. 10-3

Click to edit Master title style Gains on exchanges of similar fixed assets are not recognized for financial reporting purposes. IMPORTANT!

Click to edit Master title style 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 $

Click to edit Master title style 70 Two Methods of Determining Cost Method One List price of new equipment$5,000 Trade-in allowance$1,100 Book value of old equipment 800 Unrecognized gain on exchange (300) Cost of new equipment$4,

Click to edit Master title style 71 Method Two Book value of old equipment$ 800 Cash paid at date of exchange 3,900 Cost of new equipment$4,700 Note that either method provides the same cost for the new equipment. 10-3

Click to edit Master title style 72 On June 19, equipment was exchanged at a gain of $300. June19Accum. Depreciation—Equipment Equipment (old equipment) To record exchange of equipment. Cash Equipment (new equipment)

Click to edit Master title style 73 Losses on Exchanges For 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,

Click to edit Master title style 74 Cost of old equipment$7,000 Accumulated depreciation at date of exchange 4,600 Book value at September 7, date of exchange$2,400 Trade-in allowance on old equipment 2,000 Loss on exchange$ 400 Sept7Accum. Depreciation—Equipment Equipment Loss on Disposal of Fixed Assets Equipment Cash To record exchange of equipment with loss. 10-3

Click to edit Master title style Example Exercise 10-7 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, a.Determine the cost of the new truck for financial reporting purposes. b.Journalize the entry to record the exchange.

Click to edit Master title style 76 Follow My Example 10-7 a.$73,500 List price of new truck$75,000 Trade-in allowance on old truck ($75,000 – $63,000)$12,000 Book value of old truck ($50,000 – $39,500) 10,500 Unrecognized gain on exchange (1,500) Cost of new truck$73,500 (Continued) or 10-3

Click to edit Master title style 77 For Practice: PE 10-7A, PE 10-7B 77 Follow My Example 10-7 Book value of old truck ($50,000 – $39,5000)$10,500 Plus cash paid at date of exchange 63,000 Cost of new truck$73,500 b.Truck (new)73,500 Accumulated Depreciation— Truck (old)39,500 Truck (old)50,000 Cash63,

Click to edit Master title style 78 Compute depletion and journalize the entry for depletion. Objective

Click to edit Master title style 79 The process of transferring the cost of natural resources to an expense account is called depletion. Natural Resources 10-4

Click to edit Master title style 80 Recording Depletion 10-4 A 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).

Click to edit Master title style 81 Dec. 31Depletion Expense Accumulated Depletion Depletion of mineral deposit. Adjusting Entry 10-4 If 90,000 tons are mined during the year, an adjusting entry is required at the end of the accounting period.

Click to edit Master title style Example Exercise 10-8 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. 82 a.Determine the depletion rate. b.Determine the amount of depletion expense for the current year. c.Journalize the adjusting entry on December 31 to recognize the depletion expense.

Click to edit Master title style 83 For Practice: PE 10-8A, PE 10-8B 83 Follow My Example 10-8 a.$0.90 per ton = $45,000,000/50,000,000 tons b.$11,340,000 – (12,600,000 tons x $0.90 per ton) c.Dec. 31Depletion Expense11,340,000 Accumulated Depletion11,340,000 Depletion of mineral deposit. 10-4

Click to edit Master title style 84 Describe the accounting for intangible assets, such patents, copyrights, and goodwill. Objective

Click to edit Master title style 85 Intangible Assets Patents, 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. 10-5

Click to edit Master title style 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. 10-5

Click to edit Master title style 87 At the beginning of its fiscal year, a business acquires a patent right for $100,000. Its remaining useful life is estimated at 5 years Journalizing Amortization of a Patent Dec. 31Amortization Expense—Patents Patents Patent amortization ($100,000/5). Adjusting Entry 87

Click to edit Master title style Dec. 31Amortization Expense—Patents Patents Patent amortization ($100,000/5). Adjusting Entry Because 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. 88

Click to edit Master title style 89 The 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 Copyright

Click to edit Master title style 90 A 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 Trademark

Click to edit Master title style 91 In 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 Goodwill

Click to edit Master title style 92 Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction. 10-5

Click to edit Master title style 93 Impaired Goodwill 10-5 A loss should be recorded if the business prospects of the acquired firm (and the acquired goodwill) become significantly impaired. Mar. 19 Loss from Impaired Goodwill Goodwill Impaired goodwill. 93

Click to edit Master title style Example Exercise 10-9 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. a.Journalize the adjusting entry on December 31, for the impaired goodwill. b.Journalize the adjusting entry on December 31 for the amortization of the patent rights. 94

Click to edit Master title style 95 For Practice: PE 10-9A, PE 10-9B Follow My Example 10-9 a.Dec. 31 Loss from Impaired Goodwill40,000 Goodwill40,000 Impaired goodwill b.Dec. 31 Amortization Expense—Patents3,500 Patents3,500 Amortized patent rights [($84,000/12) x (6/12)].

Click to edit Master title style 96 Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. Objective

Click to edit Master title style  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. Office equipment$125,750 Less accumulated depreciation 86,300 Net book value$ 39,450

Click to edit Master title style  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.

Click to edit Master title style Fixed Assets and Intangible Assets in the Balance Sheet

Click to edit Master title style Fixed Asset Turnover Ratio One 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 Ratio Revenue Average Book Value of Fixed Assets =

Click to edit Master title style Financial Analysis and Interpretation For Marriott International, Inc. (in millions) Fixed Asset Turnover Ratio Revenue Average Book Value of Fixed Assets = Fixed Asset Turnover Ratio $11,550 ($2, ,389)/2 = Fixed Asset Turnover Ratio = 4.88 Conclusion: For every dollar of fixed assets, Marriott earns $4.88 of revenue.