1. Fixed Assets and Intangible Assets Financial and Managerial Accounting
Chapter 9
Fixed Assets and Intangible Assets
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.
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PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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3. After studying this chapter, you should be able to:
Objectives
1. Define fixed assets and describe the accounting for their cost.
2. Compute depreciation, using the following methods: straight-line method, units-of-production method, and declining-balance method.
3. Classify fixed asset costs as either capital expenditures or revenue expenditures.
4. Journalize entries for the disposal of fixed assets.
5. Define a lease and summarize the accounting rules related to the leasing of fixed assets.
After studying this chapter, you should be able to:

4. Objectives 6. Describe internal controls over fixed assets.
7. Compute depletion and journalize the entry for depletion.
8. Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.
9. Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.
10. Compute and interpret the ratio of fixed assets to long-term debt.

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. Classifying Costs Expense Fixed Assets Investment
Is the purchased item long-lived?
Yes No
Expense
Is the asset used in a productive purpose?
Yes No
Fixed Assets
Investment

7. Cost of
Fixed Assets

8. Land Purchase price Sales taxes Permits from government agencies
Broker’s commissions
Title fees
Surveying fees

9. Land Purchase price Sales taxes Delinquent real estate taxes
Permits from government agencies
Broker’s commissions
Title fees
Surveying fees
Delinquent real estate taxes
Razing or removing unwanted buildings, less the salvage
Grading and leveling
Paving a public street bordering the land

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

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

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

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

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

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. Nature of Depreciation
All fixed assets except land lose their capacity
to provide services. This loss of productive capacity is recognized as Depreciation Expense.
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 longer able to provide services at the level for which it was intended, e.g., personal computer.

17. Depreciation Expense Factors
Initial Cost
Residual Value - =
Depreciable Cost
Useful Life 1
Periodic Depreciation Expense 2 3 4 5

18. Use of Depreciation Methods
Units-of-Production
Other
Declining- Balance 5% 8% 4%
83%
Straight-Line
Source: Accounting Trends & Techniques, 56th. ed., American Institute of Certified Public Accountants, New York, 2002.

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

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

21. $24,000 – $2,000 Straight-Line Method 5 years
= $4,400 annual depreciation

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

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. Straight-Line Method Annual 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 $4,400 $19,600
2 24,000 $ 4,400 19,600 4,400 15,200
3 24,000 8, ,200 4, ,800
4 24,000 13, , , ,400
5 24,000 17,600 6,400 4,400 2,000
Annual Depreciation
Expense ($4,400)
Cost ($24,000) – Residual Value ($2,000) =
Estimated Useful Life (5 years)

25. Units-of-Production Method
Cost – estimated residual value
Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.

26. Units-of-Production Method
$24,000 – $2,000
10,000 hours
= Depreciation per unit, hour, etc.
= $2.20 per hour

27. Units-of-Production Method
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.

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

29. Declining-Balance Method
There’s a shortcut. Simply divide one by the number of years (1 ÷ 5 = .20).

30. Declining-Balance Method
Step 2
Double the straight-line rate.
.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 40 percent.

31. Declining-Balance Method
Step 3
Build a table.

32. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600
$24,000 x .40

33. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400

34. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760
$14,400 x .40

35. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640

36. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184

37. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110

38. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
STOP!
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866

39. Declining-Balance Method
If we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of Year 5 is expected to be $2,000, so we must modify our approach.
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866

40. Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3, ,110
$3,110 – $2,000

41. Desired ending book value
Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec Book Value
Year of Year Rate Deprec Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3, ,110 22,000 2,000
Desired ending book value

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

43. Revising
Depreciation
Estimates

44. Revising Depreciation Estimates
A machine purchased for $130,000 was originally estimated to have a useful life of 30 years and a residual value of $10,000. The asset has been depreciated for ten years using the straight line method.
Annual Depreciation
$130,000 – $10,000
30 years
$4,000 per year

45. Revising Depreciation Estimates
Accumulated Depreciation
Equipment
130,000
4,000
40,000
Book value = $90,000
Before revising

46. Revising Depreciation Estimates
During the eleventh year, it is estimated that the remaining useful life is 25 years (rather than 20) and that the revised estimated residual value is $5,000.
Book value – revised residual value
Revised estimated remaining life
$90,000 – $5,000
25 years
$3,400 revised annual depreciation =

47. Capital and Revenue Expenditures
Expenditures made to acquire new plant assets are known as capital expenditures.

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

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

50. 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

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

52. 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:
An asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove it’s balance from the ledger.

53. Discarding Fixed Assets
A piece of equipment acquired at a cost of $25,000 is fully depreciated. On February 14, the equipment is discarded.

54. Discarding Fixed Assets
Feb. 14 Accumulated Depr.—Equipment
Equipment
To write off fully depreciated equipment.

55. Discarding Fixed Assets
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.—Equipment
$600 x 3/12
Accum. Depreciation—Equipment
To record current depreciation on equipment discarded.

56. Discarding Fixed Assets
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 Accumulated Depr.—Equipment
Loss on Disposal of Fixed Asset
Equipment
To write off equipment discarded.

57. 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.

58. Sale of Fixed Assets
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.
Oct. 12 Depreciation Expense—Equipment
Accumulated Depr.—Equipment
$10,000 x ¾ x10%
To record current depreciation on equipment sold.

59. Sale of Fixed Assets
Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.
Oct. 12 Cash
Accumulated Depr.—Equipment
Equipment
Sold equipment.

60. Sale of Fixed Assets
Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.
Oct. 12 Cash
Accumulated Depr.—Equipment
Loss on Disposal of Fixed Assets
Equipment
Sold equipment.

61. Sale of Fixed Assets
Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.
Oct. 12 Cash
Accumulated Depr.—Equipment
Equipment
Gain on Disposal of Fixed Assets
Sold equipment.

62. 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).

63. Exchanges of Similar Fixed Assets
List price of new equipment acquired $5,000
Cost of old equipment traded in $4,000
Accum. depreciation at date of exchange 3,200
Book value at date of exchange $ 800
CASE ONE (GAIN):
Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100)
TIA > Book Value = Gain
$1,100 – $800 = $300
Boot + Book = Cost of New Equipment $3,900 + $800 = $4,700
Gains are not recognized for financial reporting.

64. Exchanges of Similar Fixed Assets
On June 19, equipment exchanged at a gain of $300.
June 19 Accumulated Depr.—Equipment
Equipment (new equipment)
Equipment (old equipment)
Cash

65. Exchanges of Similar Fixed Assets
List price of new equipment acquired $10,000
Cost of old equipment traded in $7,000
Accum. depreciation at date of exchange 4,600
Book value at date of exchange $2,400
CASE TWO (LOSS):
Trade-in allowance, $2,000
Cash paid, $8,000 ($10,000 – $2,000)
TIA<Book Value = Loss
$2,000 – $2,400 = $400
Losses are recognized for financial reporting.

66. Exchanges of Similar Fixed Assets
On September 7, equipment exchanged at a loss of $400.
Sept. 7 Accumulated Depr.—Equipment
Equipment (new equipment)
Loss on Disposal of Fixed Assets
Equipment (old equipment)
Cash

67. Natural Resources and Depletion
Depletion is the process of transferring the cost of natural resources to an expense account.

68. Natural Resources and Depletion
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).

69. Natural Resources and Depletion
During the current year, 90,000 tons are mined. The periodic depletion is $36,000 (90,000 tons x $0.40).
Adjusting Entry
Dec. 31 Depletion Expense
Accumulated Depletion

70. Intangible Assets and Amortization
Amortization is the periodic cost expiration of intangible assets which do not have physical attributes and are not held for sale (patents, copyrights, and goodwill).
Date Description Debit Credit
Dec. 31 Amortization Expense 20,000
Patents 20,000
Paid $100,000 for patent rights. The patent life is 11 years and was issued 6 years prior to purchase.
11 years – 6 years = 5-year life
($100,000 / 5 years) = $20,000 per year

71. Discovery Mining Co. Partial Balance Sheet December 31, 200674
Discovery Mining Co. Partial Balance Sheet December 31, 2006
Accum. Book
Property, plant, and equipment: Cost Depr. Value
Land $ 30,000 $ 30,000
Buildings 110,000 $ 26,000 84,000
Factory equipment 650, , ,000
Office equipment 120, , ,000
$910,000 $231,000 $ 679,000
Accum. Book
Mineral deposits: Cost Depr. Value
Alaska deposit $1,200,000 $ 800,000 $400,000
Wyoming deposit , , ,000
$1,950,000 $1,000, ,000
Total property, plant, and equipment $1,629,000
Intangible assets:
Patents $ ,000
Goodwill ,000
Total intangible assets $ 125,000

72. Ratio of Fixed Assets to Long-Term Liabilities
(in millions)
Procter & Gamble
Fixed assets (net) $13,349 $13,095
Long-term debt $11,201 $9,792
Ratio of fixed assets to
long-term liabilities
Use: To indicate the margin of safety to long-term creditors

73. Chapter 9
The End