Electronic Presentation by Douglas Cloud Pepperdine University Survey of Accounting Electronic Presentation by Douglas Cloud Pepperdine University Carl S.Warren

Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

Chapter 7 Fixed Assets and Intangible Assets

After studying this chapter, you should be able to: Learning Objectives 1. Define, classify, and account for the cost of fixed assets. 2. Compute depreciation, using the straight-line, and declining-balance methods. 3. Describe the accounting for the depletion of natural resources. 4. Describe the accounting for the disposal of fixed assets. After studying this chapter, you should be able to: Continued

Learning Goals 5. Classify fixed asset costs as either capital expenditures or revenue expenditures. 6. Describe accounting for intangible assets. 7. Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets. 8. Analyze the utilization of fixed assets.

Learning Objective 1 Define, classify, and account for the cost of fixed assets.

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.

Nature of Fixed Assets If the purchased item is long-lived, then it should be capitalized, which means it is shown as an asset rather than an expense.

Expense Fixed Assets Investment Is the purchased item long-lived? no yes no Expense Is the asset used in a productive purpose? no yes Fixed Assets Investment

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

Land 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 the salvage Grading and leveling Paving a public street bordering the land

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

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

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

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

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

Learning Objective 2 Compute depreciation, using the straight-line and declining-balance methods.

Use of Depreciation Methods Source: Accounting Trends & Techniques, 55th. ed., American Institute of Certified Public Accountants, New York, 2001

Data Original Cost.....………….. $24,000 Estimated Life in years….. 5 years Estimated Residual Value... $2,000

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

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

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.

Straight-Line Method 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 8,800 15,200 4,400 10,800 4 24,000 13,200 10,800 4,400 6,400 5 24,000 17,600 6,400 4,400 2,000 Cost ($24,000) – Residual Value ($2,000) Annual Depreciation Expense ($4,400) = Estimated Useful Life (5 years)

Ending book value equals the residual value Straight-Line Method 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 8,800 15,200 4,400 10,800 4 24,000 13,200 10,800 4,400 6,400 5 24,000 17,600 6,400 4,400 2,000 Ending book value equals the residual value

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%

Declining-Balance Method = $4,800 $24,000 - $2,000 5 years $4,800 $24,000 = 20% Step 1 Ignoring residual value, determine the straight-line rate There’s a shortcut. Simply divide the number of years by one (1 ÷ 5 = .20).

Declining-Balance Method Step 2 Double the 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 by 40 percent.

Declining-Balance Method Step 3 Build a table.

Desired ending book value Declining-Balance Method Accum. Depr. Book Value. Beginning at Beginning Depr. Book Value Year of Year Rate of Year for Year Year-End 1 40% $24,000.00 $9,600.00 $14,400.00 2 $ 9,600.00 40% 14,400.00 5,760.00 8,640.00 3 15,360.00 40% 8,640.00 3,456.00 5,184.00 4 18,816.00 40% 5,184.00 2,073.60 3,110.40 5 20,889.60 --- 3,110.40 1,110.40 2,000.00 Desired ending book value $3,110.40 – $2,000.00

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

Learning Objective 3 Describe the accounting for depletion of natural resources.

Natural Resources Depletion is the periodic transferring of the cost of natural resources, such as metal ores and other minerals removed from the earth, to an expense account.

Natural Resources Paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore. During the year, 90,000 tons are mined.

Learning Objective 4 Describe the accounting for the disposal of fixed assets.

Discarding Fixed Assets An item of equipment acquired at a cost of $25,000 is fully depreciated with no salvage value at December 31, 2004. On February 14, 2005, the equipment is discarded.

Discarding Fixed Assets Equipment costing $6,000 is depreciated at an annual straight-line rate of 10%. The Accumulated Depreciation balance related to this equipment is $4,900. The asset is removed from service on March 24.

Selling Fixed Assets Equipment is acquired at a cost of $10,000 and is depreciated at an annual straight-line rate of 10%. It is sold for $1,000 cash on October 12 of the eighth year of its use. The balance in Accumulated Depreciation is $7,750.

Learning Objective 5 Classify fixed asset costs as either capital expenditures or revenue expenditures.

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.

Capital and Revenue Expenditures Expenditures made for acquiring, constructing, adding, or replacing fixed assets are known as capital expenditures.

Learning Objective 6 Describe the accounting for intangible assets.

Patents The exclusive right granted by the federal government to produce and sell goods with one or more unique features is a patent. Patent Office ?

Patents Maximum life 20 years Costs: Initial cost of purchased patent Any related legal fees The straight-line method normally is used to amortize patents.

Patents A business acquires patent rights for $100,000. The patent had been granted 6 years earlier by the Federal Patent Office. The remaining useful life is estimated at 5 years.

Copyrights and Trademarks The exclusive right to publish and sell a literary, artistic, or musical composition is granted by a copyright. A copyright has a maximum life of 70 years beyond the death of the author.

Copyrights and Trademarks A trademark is a name, term, or symbol used to identify a business and its products.

Goodwill Goodwill refers to an intangible asset of the business that is created from such favorable factors as location, production quality, reputation, and managerial skills.

Learning Objective 7 Describe how depreciation expense is reported in an income statement, and prepare a balance sheet that includes fixed assets and intangible assets.

Discovery Mining Co. Partial Balance Sheet December 31, 2005 Accum. Book Property, plant, and equipment: Cost Depr. Value Land $ 30,000 $ 30,000 Buildings 110,000 $ 26,000 84,000 Factory equipment 650,000 192,000 458,000 Office equipment 120,000 13,000 107,000 $910,000 $231,000 $ 679,000 Accum. Book Mineral deposits: Cost Depr. Value Alaska deposit $1,200,000 $ 800,000 $400,000 Wyoming deposit 750,000 200,000 550,000 $1,950,000 $1,000,000 950,000 Total property, plant, and equipment $1,629,000 Intangible assets: Patents $ 75,000 Goodwill 50,000 Total intangible assets $125,000

Partial Income Statement for the Year Ended December 31, 2005 Parker Company Partial Income Statement for the Year Ended December 31, 2005 Operating Expenses: Delivery expense $ 18,000 Advertising expense 33,000 Sales salaries expense 41,000 Office salaries expense 37,000 Administrative salaries 69,000 Depreciation expense 28,000 Taxes and insurance expense 22,000 Total operating expenses $248,000

Partial Statement of Cash Flows—Operating Activities Alert Company Partial Statement of Cash Flows—Operating Activities for the Year Ended December 31, 2005 Operating Activities: Net income $8,400 Adjustments to reconcile net income to cash generated by operating activities: Depreciation and amortization 3,400 Decrease in accounts receivable 800 Increase in salaries payable 400 Increase in inventory (1,600) Gain on sale of equipment (600) Net cash provided by operating activities $10,800

Partial Statement of Cash Flows—Investing Activities Alert Company Partial Statement of Cash Flows—Investing Activities for the Year Ended December 31, 2005 Investing Activities: Purchase of short-term investments $14,000 Proceeds from the sale of equipment 2,100 Payment for purchase of equipment (15,200) Purchase of long-term investments (6,000) Cash used for investing activities $(5,100)

Learning Objective 8 Analyze the utilization of fixed assets.

Operational Utilization Analysis Used portion of the fixed asset Total fixed asset capacity The closer the operational utilization approaches 100 percent, the more efficient the fixed assets.

Financial Utilization Analysis Revenue per Unit of Fixed Assets Total Revenues Number of fixed asset units Use this ratio only when there is a correlation between the number of fixed asset units and total revenues.

Financial Utilization Analysis Fixed Asset Turnover Ratio Revenue Average book value of fixed assets The larger the ratio, the more efficiently a business is using its fixed assets.

Chapter 7 The End