Fixed/ Long Term Assets Accounting

Information about long-term acquisitions can be found under investing activities in the statement of cash flows Long-Term Assets Assets have a useful life greater than one year Used in operation of a business Are not intended for resale to customers

Accounting for Fixed Assets Determining the cost of acquisition of Fixed Assets Allocating the cost of Fixed Assets Accounting for disposal of Fixed Assets

Long-Term Assets and Corresponding Expenses

Favorably impacts profitability for that current period Management must use ethical judgments when resolving two issues: 1.How much of the total cost of a long-term asset should be allocated to expense in the current period? 2.How much should be retained on the balance sheet as an asset that will benefit future period? Applying the Matching Rule When a company purchases an asset, it may choose to capitalize it, thus deferring an expense to a later period

Long-Term Assets 1.How is the cost of the long-term asset determined? 2.How should the expired portion of the cost of the long-term asset be allocated against revenues over time? 3.How should subsequent expenditures, such as repairs and additions, be treated? 4.How should disposal of the long-term asset be recorded?

Issues in Accounting for Long-Term Assets

General Approach to Acquisition Costs Low cost items Betterment, repair and maintenance Include all expenditures reasonable and necessary to get the asset in place and ready for use Include costs of installing and testing a machine; freight, insurance while in transit, and installation Interest charges are not included in the acquisition cost (these are operating expenses)

 On May 4, Heat Co., an Ohio maker of stoves, buys a new machine from a Texas company. The new machine has a price of $52,000.  Sales tax was computed at 8%.  Heat Co. pays $500 shipping cost to get the machine to Ohio.  After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs.  Compute the cost of Heat Co.’s new machine.  On May 4, Heat Co., an Ohio maker of stoves, buys a new machine from a Texas company. The new machine has a price of $52,000.  Sales tax was computed at 8%.  Heat Co. pays $500 shipping cost to get the machine to Ohio.  After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs.  Compute the cost of Heat Co.’s new machine. Determining Cost

Improvements to land such as driveways, fences, and landscaping are recorded separately. Cost includes real estate commissions, escrow fees, legal fees, clearing and grading the property. Land Improvements Land Special Considerations

Repairs made prior to the building being put in use are considered part of the building’s cost. Buildings Special Considerations

Equipment Related interest, insurance, and property taxes are treated as expenses of the current period. Special Considerations

Costs of Building Construction Materials Labor Overhead and other indirect costs Architects’ fees Insurance during construction Interest on construction loans Lawyers’ fees Building permits Outside contractors

Allocation of Cost Depreciation means the allocation of the cost of a plant asset to the periods that benefit from the service of that asset. –Does not refer to an asset’s Physical deterioration Decrease in market value over time

The allocation of the cost of a plant asset to expense in the periods in which services are received from the asset. Cost of plant assets Balance Sheet Assets: Plant and equipment Assets: Plant and equipment Income Statement Revenues: Expenses: Depreciation Revenues: Expenses: Depreciation as the services are received Depreciation

Not a Process of Valuation Depreciation is a process of allocation Accounting records are not indicators of changing price levels As an asset wears out or becomes obsolete, depreciation must be recorded

Factors in Computing Depreciation 1.Cost –Net purchase price –All reasonable and necessary expenditures to get the asset in place and ready for use 2.Residual value –An asset’s estimated scrap, salvage, or trade- in value as of the estimated date of disposal –Also called salvage value or disposal value

Factors in Computing Depreciation (cont’d) 3.Depreciable cost –Cost less residual value –Depreciable cost is allocated over the useful life of an asset 4.Estimated useful life –Total number of service units expected from a long-term asset –May be measured in years, miles, units, or similar measures

Book Value –Cost – Accumulated Depreciation Accumulated Depreciation –Contra-asset –Represents the portion of an asset’s cost that has already been allocated to expense. Causes of Depreciation –Physical deterioration –Obsolescence Book Value –Cost – Accumulated Depreciation Accumulated Depreciation –Contra-asset –Represents the portion of an asset’s cost that has already been allocated to expense. Causes of Depreciation –Physical deterioration –Obsolescence Depreciation

Cost - Residual Value Life in Years Depreciation Expense per Year = Straight-Line Depreciation

On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the straight-line method. On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the straight-line method. Straight-Line Depreciation

On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the straight-line method. On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the straight-line method.

Bass Co. will record $4,200 depreciation each year for five years. Total depreciation over the estimated useful life of the boat is: Salvage Value Straight-Line Depreciation

When an asset is acquired during the year, depreciation in the year of acquisition must be prorated. Half-Year Convention In the year of acquisition, record six months of depreciation. Half-Year Convention In the year of acquisition, record six months of depreciation. ½ Depreciation for Fractional Periods

Depreciation in the early years of an asset’s estimated useful life is higher than in later years. The double-declining balance depreciation rate is 200% of the straight-line depreciation rate of 1/Useful Life. Declining-Balance Method

On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the double- declining balance method. On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the double- declining balance method. Declining-Balance Method

On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the double- declining balance method. On January 1, 2001, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2001 using the double- declining balance method.

Compute depreciation for the rest of the boat’s estimated useful life. Declining-Balance Method

Total depreciation over the estimated useful life of an asset is the same using either the straight-line method or the declining- balance method. Declining-Balance Method

If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its net realizable value. Impairment of Assets

Update depreciation to the date of disposal. Recording cash received (debit) or paid (credit). Recording cash received (debit) or paid (credit). Removing accumulated depreciation (debit). Removing the asset cost (credit). Recording a gain (credit) or loss (debit). Recording a gain (credit) or loss (debit). Disposal of Plant and Equipment Journalize disposal by:

If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Recording cash received (debit) or paid (credit). Recording cash received (debit) or paid (credit). Removing accumulated depreciation (debit). Removing the asset cost (credit). Recording a gain (credit) or loss (debit). Recording a gain (credit) or loss (debit). Disposal of Plant and Equipment

On September 30, 2001, Evans Map Company sells a machine that originally cost $100,000 for $60,000 cash. The machine was placed in service on January 1, It has been depreciated using the straight-line method with an estimated salvage value of $20,000 and an estimated useful life of 10 years. Let’s answer the following questions. Disposal of Plant and Equipment

The amount of depreciation recorded on September 30, 2001, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. The amount of depreciation recorded on September 30, 2001, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. Disposal of Plant and Equipment

The amount of depreciation recorded on September 30, 2001, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. The amount of depreciation recorded on September 30, 2001, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. Annual Depreciation: ($100,000 - $20,000) ÷ 10 Yrs. = $8,000 Depreciation to Sept. 30: 9/12 × $8,000 = $6,000 Disposal of Plant and Equipment

After updating the depreciation, the machine’s book value on September 30, 2001, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. After updating the depreciation, the machine’s book value on September 30, 2001, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. Disposal of Plant and Equipment

After updating the depreciation, the machine’s book value on September 30, 2001, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. After updating the depreciation, the machine’s book value on September 30, 2001, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. Disposal of Plant and Equipment

The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. Disposal of Plant and Equipment

The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. Disposal of Plant and Equipment

Accounting depends on whether assets are similar or dissimilar. Airplane for Airplane Truck for Airplane Only situations where cash is paid will be demonstrated. Trading in Used Assets for New Ones

On May 30, 2001, Essex Company exchanged a used airplane and $35,000 cash for a new airplane. The old airplane originally cost $40,000, had up-to-date accumulated depreciation of $30,000, and a fair value of $4,000. SIMILAR Trading in Used Assets for New Ones – Similar Assets

The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. Trading in Used Assets for New Ones – Similar Assets

The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. Prepare a journal entry to record the exchange. Trading in Used Assets for New Ones – Similar Assets

Another Example A company has two automobiles, each originally costing $20,000, of which $15000 has been depreciated. Each has a fair value of $7000 as a used car. The first car is traded for another automobile with a list price of $30,000, and $18,000 is given in cash to the dealer in addition to the trade-in. The cost of the new car is recorded as $23,000. The second car is traded for a piece of machine with a list price of $30,000, and $18,000 is given in cash to the dealer in addition to the trade-in. Here, the cost of the new car is recorded as $25,000.

Intangible Assets Long-term assets with no physical substance Have a value based on rights, privileges, or advantages coming to or belonging to the owner Accounted for at acquisition cost –Patents –Copyrights –Leaseholds and leasehold improvements –Franchises –Licenses –Trademarks and brand names and goodwill Goodwill and trademarks should not appear on the balance sheet unless they have been purchased from another party at a price established in the marketplace.

Accounting Issues for Intangible Assets Accounting issues are similar to other long- term assets. Issues include: –Determining an initial carrying amount –Accounting for periodic write-off or amortization –Accounting for that amount if the value declines substantially and permanently Because of its intangibility, its value and useful life may be difficult to estimate.

Accounting for Intangible Assets Record as expenses –Intangible assets developed by a company for its own benefit. Record as assets –Intangible assets acquired from others Amortize over the shorter of their useful life or their legal life (not to exceed 40 years). If an intangible asset becomes worthless before it is fully amortized, the remaining carrying value should be written off as a loss.

Research and Development Costs Expenses of funding development of new products, testing of existing and proposed products, and pure research. Treat as revenue expenditures and charged to expense in the period when incurred. Are continuous and necessary for the success of a business and should be treated as current expenses. Do not necessarily result in future benefits (assets).

Computer Software Costs Costs incurred in creating computer software for sale or lease to others or for internal use. Considered R&D costs until the product has been proved to be technologically feasible. –Costs incurred up to this point are expensed as incurred. After the working program has been developed, all software production costs are recorded as assets. –Amortize over the estimated economic life of the product using the straight-line method.

Goodwill Exists when a purchaser pays more for a business than the fair market value of the net assets if purchased separately. Should be amortized over a reasonable number of future time periods, but not longer than 40 years. Should not be recorded unless it is paid for in connection with the purchase of a whole business. Goodwill = Purchase price - FMV of identifiable assets

Exclusive right granted by government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 17 years. Intangible Assets – Patents

A symbol, design, or logo associated with a business. Purchased trademarks are recorded at cost, and amortized over shorter of legal or economic life, or 40 years. Internally developed trademarks have no recorded asset cost. Intangible Assets – Trademarks and Trade Names

Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is intangible asset which is amortized over the shorter of the protected right or 40 years. Intangible Assets – Franchises

Exclusive right granted by the government to protect artistic or intellectual properties. Amortize cost over a period not to exceed 40 years. Legal life is life of creator plus 50 years. Intangible Assets – Copyrights