Fixed and Intangible Assets Chapter 10

Classifying Costs Is the asset used in normal operations? Yes – asset is recorded as a fixed asset No – asset is recorded as an investment Is the purchased item long-lived? Yes – asset recorded on balance sheet as fixed asset or an investment No – item is recorded as an expense

Capital & Revenue Expenditures Revenue Expenditures – only benefit the current period. Example: Oil change for a truck Capital Expenditures – improve the asset or extend its useful life. Example: Overhaul of an engine for a truck

Depreciation The periodic recording of the cost of fixed assets as an expense. Physical depreciation – wear and tear during use or from exposure to weather Functional depreciation – obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended

Straight-Line Method Straight-line is the most widely used depreciation. Annual depreciation = Cost – Residual Value Useful Life *************************************************** Example: Initial cost $20,000 Expected useful life 3 yrs Estimated residual value $2,000 ($20,000 - $2,000)/3 = $6,000

Units-of-Production Method Provides the same amount of depreciation for each unit produced. Depreciation per Unit = Cost-Residual Value Total Units of Production Depreciation Expense = Depreciation per Unit x Total Units Produced *********************************************************** Example: Initial Cost $20,000 Estimated residual value $2,000 Useful operating hours 1000 hrs ($20,000 - $2,000)/1000 = $18.00 per hour Operated – 100 hours $18.00 x 100 = $1,800

Double-Declining Method 1. Find the Straight-line Percentage 100%/Useful Life Example: 5 years useful life 100/5 = 20% 2. Multiply step 1 by 2 Example: 20% x 2 = 40% 3. Multiply the double-declining balance rate by the book value of the asset Example: First year book value $20,000 x 40% = $8,000 Second year book value $12,000 x 40% = $4,800 When the double-declining method is used, the estimated residual value is not considered.

Partial Depreciation If an asset is used only part of a year, the annual depreciation is prorated. Example: Straight-line method Initial cost $20,000 Expected useful life 3 yrs Estimated residual value $2,000 Placed in service October 1 ($20,000 - $2,000)/3 = $6,000 x 3/12 = $1,500

Discarding Fixed Assets A fixed asset that is no longer used and has no residual value, is discarded. Example: A piece of equipment which cost $10,000 and is fully depreciated is discarded. Accumulated Depreciation $10,000 Equipment $10,000

Discarding Fixed Assets If an asset has not been fully depreciated, depreciation should be recorded before removing the asset. Example: Equipment Cost $10,000 Straight-line method 10% The equipment is discarded on April 1. ($10,000 x 10% = $1,000 x 3/12 = $250) Depreciation Expense $250 Accumulated Depreciation – Equip $250 Accumulated Depreciation – Equip $9,250 Loss on Disposal – Equip $750 Equipment $10,000

Selling Fixed Assets Entry similar to discarding an asset except the receipt of cash is also recorded. Example: Equipment Cost $10,000 Straight-line rate 10% Sold in 8th year Acc. Depreciation Balance $8,000 Sold on October 1 Depreciation Expense $750 Acc. Depreciation $750 ($10,000 x 10%) x 9/12 = $750 See next slide for scenarios:

Selling Fixed Assets Scenarios Sold at book value no gain or loss Cash $1,250 Acc. Depreciation $8,750 Equipment $10,000 ****************************************************************** Sold below book value for $500 Cash $ 500 Acc. Depreciation $8,750 Loss on Sale – Equip $ 750 Equipment $10,000 ******************************************************************* Sold above book value for $2,000 Cash $2,000 Equipment $10,000 Gain on Sale – Equip $ 750

Natural Resources The process of transferring the cost of natural resources to an expense account is depletion. 1. Depletion Rate = Cost of Resource Estimated Total Units of Resource 2. Depletion Expense = Depletion Rate x Quantity Extracted Example: Cost of mineral deposit $200,000 Est. Total Units of Resource 1,000,000 tons Tons mined during year 50,000 tons $200,000/1,000,000 = .20 per ton .20 per ton x 50,000 tons = $10,000 Depletion Expense $10,000 Acc. Depletion $10,000

Intangible Assets Intangible assets do not physically exist. Patents are issued by government for inventions. These rights continue in effect for 20 years. They are amortized. Example: Amortization Expense – Patents $2,000 Patents $2,000 Copyright are exclusive rights to publish and sell a literary, artistic, or musical composition. These rights are good for 70 years beyond the author’s death. They are amortized Trademark is a name, term or symbol used to identify a business and its products. They can be registered for 10 years and renewed for 10 year periods. Goodwill is created from such favorable factors as location product quality, reputation, and managerial skill. They are not amortized. Loss from Impaired Goodwill $1,000 Goodwill $1,000