7-1 electronic presentation by douglas cloud pepperdine university carl s.warren survey of...

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Electronic Presentation by Douglas Cloud

Pepperdine University

Electronic Presentation by Douglas Cloud

Pepperdine University

Carl S.Warren

Survey of Accounting

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Task Force Clip Art Task Force Clip Art included in this electronic included in this electronic presentation is used with presentation is used with

the permission of New the permission of New Vision Technology of Vision Technology of

Nepean Ontario, Canada.Nepean Ontario, Canada.

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Fixed Assets and Intangible Assets

Chapter 7

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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.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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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 GoalsLearning GoalsLearning GoalsLearning Goals

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1Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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

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Nature of Fixed AssetsNature of Fixed AssetsNature of Fixed AssetsNature of Fixed Assets

Fixed assets are long term or relatively permanent assets

Fixed assets are long term or relatively permanent assets

Fixed assets are tangible assets because they exist physically.

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.

They are owned and used by the business and are not held for sale as

part of normal operations.

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Nature of Fixed AssetsNature of Fixed AssetsNature of Fixed AssetsNature 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.

If the purchased item is long-lived, then it should be capitalized, which means it is shown as an asset rather

than an expense.

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yes

Fixed Assets

no

Is the purchased item long-lived?

Is the asset used in a productive purpose?

yes no

Expense

Investment

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LandLandLandLand

• Purchase pricePurchase price• Sales taxesSales taxes• Permits from government Permits from government

agenciesagencies• Broker’s commissionsBroker’s commissions• Title feesTitle fees• Surveying feesSurveying fees

• Purchase pricePurchase price• Sales taxesSales taxes• Permits from government Permits from government

agenciesagencies• Broker’s commissionsBroker’s commissions• Title feesTitle fees• Surveying feesSurveying fees

ContinuedContinuedContinuedContinued

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• Purchase pricePurchase price• Sales taxesSales taxes• Permits from government Permits from government

agenciesagencies• Broker’s commissionsBroker’s commissions• Title feesTitle fees• Surveying feesSurveying fees

• Purchase pricePurchase price• Sales taxesSales taxes• Permits from government Permits from government

agenciesagencies• Broker’s commissionsBroker’s commissions• Title feesTitle fees• Surveying feesSurveying fees

• Delinquent real estate taxesDelinquent real estate taxes• Razing or removing Razing or removing

unwanted buildings, less the unwanted buildings, less the salvagesalvage

• Grading and levelingGrading and leveling• Paving a public street Paving a public street

bordering the landbordering the land

• Delinquent real estate taxesDelinquent real estate taxes• Razing or removing Razing or removing

unwanted buildings, less the unwanted buildings, less the salvagesalvage

• Grading and levelingGrading and leveling• Paving a public street Paving a public street

bordering the landbordering the land

LandLandLandLand

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BuildingsBuildings

Architects’ fees Engineers’ fees Insurance costs incurred

during construction Interest on money

borrowed to finance construction

Walkways to and around the buildingContinuedContinuedContinuedContinued

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Sales taxes Repairs (purchase of

existing building) Reconditioning

(purchase of an existing building)

Modifying for use Permits from

governmental agencies

BuildingsBuildings

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• Trees and shrubs

• Fences

• Outdoor lighting

• Concrete sewers and drainage

• Paved parking areas

Land ImprovementsLand Improvements

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Machinery and EquipmentMachinery and Equipment

• Sales taxes• Freight• Installation• Repairs (purchase of used

equipment)• Reconditioning (purchase

of used equipment)

ContinuedContinued

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• Insurance while in transit

• Assembly

• Modifying for use

• Testing for use

• Permits from governmental agencies

Machinery and EquipmentMachinery and Equipment

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

Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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Use of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation Methods

S/LDBUOPOther

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

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DataDataDataData

Original Cost.....………….. $24,000

Estimated Life in years….. 5 years

Estimated Residual Value... $2,000

Original Cost.....………….. $24,000

Estimated Life in years….. 5 years

Estimated Residual Value... $2,000

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Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Cost – estimated residual value

Estimated life

= Annual depreciation

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Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

$24,000 – $2,000

5 years

= $4,400 annual depreciation

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Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-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.

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.

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Accum. Depr. Book Value Depr. Book Valueat 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

Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Cost ($24,000) Cost ($24,000) –– Residual Value ($2,000) Residual Value ($2,000)

Estimated Useful Life (5 years)Estimated Useful Life (5 years)=

Annual DepreciationAnnual DepreciationExpense ($4,400)Expense ($4,400)

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Accum. Depr. Book Value Depr. Book Valueat 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 valueEnding book value equals the residual value

Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

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Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

Step 1Step 1

Ignoring residual value, determine the straight-line rate

= $4,800 $24,000 - $2,000

5 years

$4,800

$24,000= 20%

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Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

= $4,800 $24,000 - $2,000

5 years

$4,800

$24,000= 20%

Step 1Step 1

Ignoring residual value, determine the straight-line rate

There’s a shortcut. Simply divide the number of years by

one (1 ÷ 5 = .20).

There’s a shortcut. Simply divide the number of years by

one (1 ÷ 5 = .20).

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Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

Double the rate.

Step 2Step 2

.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.

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.

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Build a table.

Step 3Step 3

Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

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Accum. Depr. Book Value. Beginning at Beginning Depr. Book ValueYear 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

Declining-Balance MethodDeclining-Balance MethodDeclining-Balance MethodDeclining-Balance Method

$3,110.40 – $2,000.00$3,110.40 – $2,000.00Desired ending book value

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Comparing Straight-Line With the Comparing Straight-Line With the Declining-Balance MethodDeclining-Balance Method

Comparing Straight-Line With the Comparing Straight-Line With the Declining-Balance MethodDeclining-Balance Method

Straight-LineMethod

Dep

reci

atio

n ($

)

5,000

4,000

3,000

2,000

1,000

0Life (years)

Declining-BalanceMethod

Life (years)

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Describe the accounting for depletion of natural resources.3

Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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Natural ResourcesNatural ResourcesNatural ResourcesNatural 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.

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.

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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.

Natural ResourcesNatural ResourcesNatural ResourcesNatural Resources

LiabilitiesDec. 31

Net Effect

Revenue Net IncomeDec. 31 -36,000

Net Effect -36,000

Trans. Date

Trans. Date

Income StatementExpense

Depletion Expense 36,000

36,000

(Net Income)

-36,000 -36,000

Retained Earnings

Balance SheetAssets Stockholders' Equity

Accum. Depletion 36,000

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Describe the accounting for the disposal of fixed assets.4

Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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Discarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed AssetsAn 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.

LiabilitiesFeb. 14

Net Effect

Revenue Net Income

Trans. Date

Trans. Date

Income StatementExpense

Acc. Deprec. -25,000

0

Balance SheetAssets Stockholders' Equity

Equipment - 25,000

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Discarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed AssetsDiscarding Fixed AssetsEquipment 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.

LiabilitiesMar. 24

Net Effect

Revenue Net IncomeMar. 24 -1,100

Net Effect -1,100

Trans. Date

Trans. Date

Income StatementExpense

Loss on Disposal 1,100

1,100

Retained Earnings

(Net Income)

Acc. Deprec. - 4,900

-1,100 -1,100

Balance SheetAssets Stockholders' Equity

Equipment - 6,000

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Selling Fixed AssetsSelling Fixed AssetsSelling Fixed AssetsSelling Fixed AssetsEquipment 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.

LiabilitiesOct. 12

Net Effect

Revenue Net IncomeOct. 12 -1,250

Net Effect -1,250

Balance SheetAssets Stockholders' Equity

Cash 1,000

Ret. Earnings (Net Income)

Equipment - 10,000

Acc. Deprec. - 7,750

Trans. Date

Trans. Date

Income StatementExpense

Loss on Sale of Equipment 1,250

1,250

-1,250 -1,250

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5Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

Classify fixed asset costs as either capital expenditures or revenue expenditures.

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Expenditures to repair or maintain plant assets that do

not extend the life or enhance the value are known as 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 ExpendituresCapital and Revenue ExpendituresCapital and Revenue ExpendituresCapital and Revenue Expenditures

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Expenditures made for acquiring, constructing, adding,

or replacing fixed assets are known as capital expenditures.

Expenditures made for acquiring, constructing, adding,

or replacing fixed assets are known as capital expenditures.

Capital and Revenue ExpendituresCapital and Revenue ExpendituresCapital and Revenue ExpendituresCapital and Revenue Expenditures

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Describe the accounting for intangible assets.6

Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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PatentsPatentsPatentsPatents

??Patent Office

The exclusive right granted by the

federal government to produce and sell goods with one or

more unique features is a patent.

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PatentsPatentsPatentsPatents

Maximum life 20 years

Costs: Initial cost of purchased patent Any related legal fees

The straight-line method normally is used to amortize patents.

The straight-line method normally is used to amortize patents.

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PatentsPatentsPatentsPatentsA 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.

LiabilitiesDec. 31

Net Effect

Revenue Net IncomeDec. 31 -20,000

Net Effect -20,000

Trans. Date

Trans. Date

Income StatementExpense

Amort. Expense - Patents 20,000

20,000

(Net Income)

-20,000 -20,000

Retained Earnings

Balance SheetAssets Stockholders' Equity

Patents - 20,000

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Copyrights and TrademarksCopyrights and TrademarksCopyrights and TrademarksCopyrights 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.

A copyright has a maximum life of 70 years beyond the death of the author.

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Copyrights and TrademarksCopyrights and TrademarksCopyrights and TrademarksCopyrights and Trademarks

A trademark is a name, term, or symbol used to

identify a business and its products.

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GoodwillGoodwillGoodwillGoodwill

Goodwill refers to an intangible asset of the business that is created from such favorable

factors as location, production quality, reputation, and managerial skills.

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

7Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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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 $ 75,000Goodwill 50,000 Total intangible assets $125,000

Discovery Mining Co.Partial Balance Sheet

December 31, 2005Accum. Book

Property, plant, and equipment: Cost Depr. Value

Land $ 30,000 $ 30,000Buildings 110,000 $ 26,000 84,000Factory equipment 650,000 192,000 458,000Office equipment 120,000 13,000 107,000

$910,000 $231,000 $ 679,000

Accum. Book Mineral deposits: Cost Depr. Value

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Parker CompanyPartial Income Statement

for the Year Ended December 31, 2005

Operating Expenses:Delivery expense $ 18,000Advertising expense 33,000Sales salaries expense 41,000Office salaries expense 37,000Administrative salaries 69,000Depreciation expense 28,000Taxes and insurance expense 22,000 Total operating expenses $248,000

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Alert CompanyPartial Statement of Cash Flows—Operating Activities

for the Year Ended December 31, 2005

Operating Activities:Net income $8,400Adjustments to reconcile net income to cashgenerated by operating activities:

Depreciation and amortization 3,400Decrease in accounts receivable 800Increase in salaries payable 400Increase in inventory (1,600)Gain on sale of equipment (600)

Net cash provided by operating activities $10,800

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Alert CompanyPartial Statement of Cash Flows—Investing Activities

for the Year Ended December 31, 2005

Investing Activities:Purchase of short-term investments $14,000Proceeds from the sale of equipment 2,100Payment for purchase of equipment (15,200)Purchase of long-term investments (6,000) Cash used for investing activities $(5,100)

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Analyze the utilization of fixed assets.8

Learning ObjectiveLearning ObjectiveLearning ObjectiveLearning Objective

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Operational Utilization Operational Utilization AnalysisAnalysis

Operational Utilization Operational Utilization AnalysisAnalysis

Used portion of the fixed asset

Total fixed asset capacity

The closer the operational utilization approaches 100 percent, the more

efficient the fixed assets.

The closer the operational utilization approaches 100 percent, the more

efficient the fixed assets.

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Financial Utilization Financial Utilization AnalysisAnalysis

Financial Utilization Financial Utilization AnalysisAnalysis

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.

Use this ratio only when there is a correlation between the number of fixed

asset units and total revenues.

Revenue per Unit of Fixed AssetsRevenue per Unit of Fixed Assets

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Financial Utilization Financial Utilization AnalysisAnalysis

Financial Utilization Financial Utilization AnalysisAnalysis

Revenue

Average book value of fixed assets

The larger the ratio, the more efficiently a business is using its fixed assets.

The larger the ratio, the more efficiently a business is using its fixed assets.

Fixed Asset Turnover RatioFixed Asset Turnover Ratio

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The EndThe End

Chapter 7Chapter 7

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