Accounting II Professor Hopkins Unit 4 Chapter 10 Fixed and Intangible Assets 1

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. If an asset is offered for sale as a normal part of business it is inventory which is a current asset. Fixed Assets p 441 2

Notice that all costs spent to acquire and to get the asset in place and ready to use are included in the cost of the asset. For Example: Permits to build a building are part of the cost of that building. Surveying fees would be included in the total cost of buying land. Look at Exhibit 3 Cost of Acquiring Fixed Assets p 443 3

Capital vs Revenue Expenditures p 444 How do we distinguish between ordinary repairs and maintenance and capital improvements? Repairs are expenses and improvements would increase the asset account. A repair or ordinary maint. are costs that attempt to hold the asset as it is today. An improvement will extend the life of the asset or improve it. 4

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. Depreciation p 446 5

Factors in Computing Depreciation p 447 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 (residual value). We will only know one of these items for fact to begin with. 6

Straight-Line Method 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 7

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. Example Exercise 10-2 (page 449) 8

(a)$120,000 ($125,000 – $5,000) cost minus RV (b)10% = (1/10) or 100% of the asset divided by the number of years used 100%/10 years = 10% (c)$12,000 ($120,000 x 10%) or ($120,000 ÷ 10 years) 9

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 $10,000. 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. Example Exercise 10-6 (page 456) – since this is the one required let’s do it now 10

EE 10-6 p 456 letter a a. What is the depreciation for the first year? Well, we need to get the depreciable amount first. The cost was? $91,000 Do we have a residual value? Yep, $10,000 So, the amount we can depreciate is $91,000 – 10,000 or $81,000. To get depreciation for one year we take the $81,000 and divide by the number of years which is 9. Therefore, depreciation for one year is? 11

EE 10-6 p 456 letter b 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. First, we need to find the book value of that asset. Remember that book value is cost minus accumulated depreciation or all of the depreciation up to that point. Since this is the end of year two we have two years of depreciation. So cost minus accum depreciation would be? 12

EE 10-6 letter b con’t. So we have book value as: Cost $91,000 – two years depr 18,000 = $73,000. And we sold it for how much? $78,000 – so did we sell for a gain or a loss and then how much? 13

EE 10-6 part c Finally, journalize the entry to record the sale. Debit or credit the asset? Debit or credit the accum depr? What do we do with the cash? At this point we have $96,000 in debits (cash and accum depr) and 91,000 in credits. We don’t balance, we need 5K on the credit side. Does that number sound familiar? 14

a.$ 9,000 [($91,000 – $10,000)/9] per full year b.$5,000 gain; $78,000 – [$91,000 – ($9,000 x 2)] c.Cash78,000 Accum. Depreciation—Equipment18,000 Equipment91,000 Gain on Disposal of Fixed Assets5,000 Example Exercise 10-6 (page 449) b. You need to get the book value to decide if you sold for a gain or a loss. Remember that we get book value by taking cost minus accumulated depr. 15

Units-of-Production Method p 449 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. 16

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 Method 17

Equipment acquired at a cost of $180,000 has an estimated residual value of $10,000 and an estimated useful life of 40,000 hours, and was operated 3,600 hours during the year. Determine the (a) depreciable cost, (b) the depreciation rate, and (c) the units-of-production depreciation for the year. Example Exercise 10-3 (page 449) 18

Example Exercise 10-3 (page 449) (a)$170,000 ($180,000 – $10,000) cost minus RV (b)$4.25 per hour which is the depreciable cost of $170,000 divided by the number of hours we expected to be able to use it or 40,000 hours. (c)$15,300 (3,600 hours x $4.25 per hour) the 3600 was given to us in the story. 19

Double-Declining-Balance Method p 450 The double-declining- balance method provides for a declining periodic expense over the estimated useful life of the asset. It is just accelerated at the beginning of the asset life. 20

Equipment 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) the double-declining-balance rate and (b) the double-declining-balance depreciation for the first year. So let’s start by talking about the double-declining- balance rate. Example Exercise 10-4 (page 450) 21

Double-Declining-Balance To get our rate we just double (hey that is where they get the name) the straight line rate. But they didn’t give us the straight line rate? No, problem we can figure it out. Since it is a 10 year asset the straight line rate would be 10% or 1/10 th per year (100% divided by 10 years). So we double that to make 20% and we have our rate. 22

Let’s Test Ourselves What would be the double-declining- balance rate if the asset had a life of: 5 years? 20 years? 8 years? 23

Example Exercise 10-4 (page 450) (a)20% (100% divided by 10 years times 2 or 1/10 times 2). (b)$25,000 ($125,000 X 20%) the trick to remember is that we do not deduct the RV when determining the depreciation it would have been too easy to be consistent Another note – you need to watch the depreciation on the last year, right? You can’t depreciate lower than the RV. 24

Summary of Depreciation Methods 25

Natural Resources p 456 Natural Resources are fixed assets held by a company and would include timber, metal ores and any other natural resources. The resource has a value and when you use up some of it (which would mean mining it and selling it) you would debit that amount to your expense account. The difference between a natural resource and equipment is that we use an account titled depletion instead of depreciation. The process of moving the cost of your natural resource to an expense account as we use it up is very similar to using the units-of- production method of depreciation. Make sure you me if you have any questions as you review this section of the chapter (hint: you have a homework problem on it). 26

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. 27

Questions??? Note the special instructions on the discussion assignment – requires two references and the length minimum is 250 words versus the normal 50 words long Textbook Exercises: Problem 10-2A – compare 3 methods (Example Exercises 10-2, 10-3, 10-4 & Exhibit 7) Problem 10-6A – intangible assets (Example Exercises 10-7 and 10-8) 28