accounting: fixed & intangible assets
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Fixed Assets and
Intangible Assets
By Mr. Breitsprecher
Fixed Assets
• Long-term or relatively permanent assets such
as equipment, machinery, buildings, and land
• Other descriptive titles for plant assets or
property, plant, and equipment
• Fixed assets have the following characteristics:
• Exist physically and, thus, are tangible assets
• Owned & used by in normal operations
• Not offered by sale as part of operations
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 2
Classifying Costs
• Incurred cost may be classified as a fixed asset, an
investment, or an expense
• Fixed assets include land, buildings, or equipment
• These assets normally last more than a year and are
used in the normal operations
• Investments are long-lived assets, not used in the
normal operations and are held for future resale
• Such assets are reported on the balance sheet in a
section entitled Investments
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 3
Cost of Fixed Assets
• Only costs necessary for preparing fixed assets for use are included as cost of the asset
• Unnecessary costs that do not increase the asset’s usefulness are recorded as an expense
• These include the following:• Vandalism• Mistakes in installation• Uninsured theft• Damage during unpacking and installing• Fines for not obtaining proper permits from
governmental agencies
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 4
Capital and Revenue
Expenditures
• Costs that benefit only current period, such as
ordinary maintenance and repairs, are called revenue
expenditures
• Recorded as increases to Repairs and Maintenance
Expense
• Costs that improve the asset or extend its useful life,
such as improvements or extraordinary repairs, are
called capital expenditures
• Recorded as increases to the fixed asset account
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 5
Extraordinary Repairs• Costs related to extraordinary repairs are capital
expenditures
• Recorded as a decrease in an accumulated depreciation
account
• For example, the engine of a forklift that is near the end
of its useful life may be overhauled at a cost of $4,500,
extending its useful life by eight years. This is recorded as:
• Forklift’s remaining useful life has changed, Depreciation
for the forklift will change based on the new book value
of the forklift
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 6
Leasing Fixed Assets• Lease is a contract for the use of an asset for a period of
time
• The parties to a lease contract are as follows:
• Lessor owns the asset
• Lessee receives rights to use asset as granted by the
lessor
• Leasing an asset has the following advantages:
• Lessee has access to an asset without having to finance
purchase of asset
• Expenses such as repair and maintenance may be the
responsibility of the lessor
• Risk of additional cost as asset becomes obsolete
before the end of its useful life is minimized
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 7
Depreciation
• Over time, fixed assets, with exception of
land, lose ability to provide services
• Costs of fixed assets such as equipment &
buildings should be recorded as expense over
useful life
• This periodic recording of fixed asset costs is
an expense is called depreciation
• Land has an unlimited life -- it is not
depreciated
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 8
Accounting for Depreciation
• Adjusting entry to record depreciation debits
Depreciation Expense and credits a contra asset
account entitled Accumulated Depreciation or
Allowance for Depreciation
• The use of a contra asset account allows original cost
to remain unchanged in original fixed asset account
• Depreciation can be caused by physical or functional
factors
• Physical depreciation factors include wear and tear
• Functional depreciation factors includes obsolescence
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 9
Computing
Depreciation Expense (1 of 2)• Three factors determine depreciation expense for fixed
assets:
• Asset’s initial cost
• Asset’s expected useful life
• Estimated at time asset is placed into service;
available from industry trade associations
• Asset’s estimated residual value
• Residual value of fixed asset at the end of its
useful life is also estimated at the time the asset is
placed into service
• Residual value also called scrap value, salvage value,
or trade-in value
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 10
Computing
Depreciation Expense (2 of 2)
• Difference between fixed asset’s initial cost and its
residual value is called asset’s depreciable cost.
• Depreciable cost is the amount of the
asset’s cost that is allocated over useful life
as depreciation expense.
• If fixed asset has no residual value, then its entire
cost should be allocated to depreciation
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 11
Straight-Line Method• Straight-line method provides same amount of
depreciation expense for each year of asset’s useful life:
Annual Depreciation = (Cost – Residual Value) / Useful Life
• If asset is used for only part of year, annual
depreciation is prorated
• Computation of straight-line depreciation may be
simplified by converting annual depreciation to a
percentage of depreciable cost
• Straight-line percentage is determined by dividing 100%
by the number of years of expected useful life
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 12
Units-of-Output Method• Units-of-output method provides same amount of
depreciation expense for each unit of output of asset
• Depending on asset, units of output can be expressed in
terms of hours, miles driven, or quantity produced
• Units-of-output method is applied in two steps:
• Step 1. Determine the depreciation per unit as follows:
• Step 2. Compute the depreciation expense as follows:
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 13
Double-Declining-
Balance Method (1 of 2)
• Double-declining-balance method provides for a
declining periodic expense over expected useful life of asset
• Double-declining-balance method has three steps:
• Step 1. Determine straight-line percentage, using
expected useful life
• Step 2. Determine double-declining-balance rate by
multiplying straight-line rate from Step 1 by 2
• Step 3. Compute depreciation expense by multiplying
double-declining-balance rate from Step 2 times the
book value of asset. For first year, book value of asset
is its initial cost
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 14
Double-Declining-
Balance Method (2 of 2)
• Double-declining-balance method provides higher
depreciation in first year of asset’s use, followed by
declining depreciation amounts
• It is called an accelerated depreciation method
• Asset’s revenues are often greater in early years of
use than in later years
• In such cases, double-declining-balance method
provides a good matching of depreciation expense
with asset’s revenues
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 15
Depreciation for Federal
Income Tax• Internal Revenue Code uses Modified Accelerated Cost
Recovery System (MACRS) to compute depreciation for tax
purposes
• MACRS has eight classes of useful life and depreciation
rates for each class
• Two of the most common classes are:
• The five-year class includes automobiles and light-duty
trucks
• The seven-year class includes most machinery and
equipment
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 16
Revising
Depreciation Estimates
• Estimates of residual values and useful lives of
fixed assets may change
• Abnormal wear and tear or obsolescence
• When new estimates are determined, they are
used to determine depreciation expense in future
periods
• Depreciation expense recorded in earlier years is
not affected
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 17
Discarding Fixed Assets
• If fixed asset is no longer used and has no residual value, it is discarded
• Entry to record disposal of a fixed asset removes cost of the asset and its accumulated depreciation from accounts
• A loss is recorded if balance of accumulated depreciation account is less than balance in fixed asset account
• These losses are reported on income statement.• If asset has not been fully depreciated, depreciation
should be recorded before removing asset from accounting records
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 18
Selling Fixed Assets
• Entry to record sale of fixed asset is similar to
entry for discarding an asset
• D difference is that receipt of cash is also
recorded
• If selling price is more than book value of asset, a
gain is recorded
• If selling price is less than book value, a loss is
recorded
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 19
Natural Resources (1 of 2)
• Fixed assets of some companies include timber,
metal ores, minerals, or other natural resources
• As resources are harvested or mined and then
sold, a portion of their cost is debited to an
expense account
• This process of transferring the cost of natural
resources to an expense account is called
depletion
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 20
Natural Resources (2 of 2)
• Depletion is determined as follows:
• Step 1. Determine depletion rate as follows:
• Step 2. Multiply depletion rate by quantity extracted
from resource during period
• Adjusting entry to record depletion debits depletion
expense & credits accumulated depletion
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 21
Intangible Assets• Patents, copyrights, trademarks, and goodwill are long-
lived assets used in the operations of a business and
are not held for sale
• Called intangible assets as they do not exist physically
• Accounting for intangible assets is similar to that for
fixed assets. Major issues are:
• Determining initial cost
• Determining amortization, which is amount of
cost to transfer to expense
• Amortization results from passage of time or a
decline in usefulness of intangible asset
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 22
Patents (1 of 2)
• Manufacturers may acquire exclusive rights to produce
and sell goods with unique features
• Such rights are granted by patents, which federal
government issues to inventors
• These rights continue in effect for 20 years
• Business may purchase patent rights from others
• However, if a company develops its own patent
through research and development, costs are usually
recorded as current operating expenses in period in
which they are incurred
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 23
Patents (2 of 2)
• Initial cost of purchased patent, including any legal
fees, is debited to an asset account
• This cost is written off, or amortized over years of the
patent’s expected useful life
• Patent amortization is normally computed using
straight-line method
• Amortization is recorded by debiting an amortization
expense account and crediting the patents account
• A separate contra asset account is usually not used for
intangible assets
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 24
Copyrights and Trademarks (1 of 2)
• Exclusive right to publish and sell a literary, artistic, or
musical composition is granted by copyright
• Copyrights are issued by federal government and extend
for 70 years beyond author’s death
• Costs of a copyright include all costs of creating the
work plus any other costs of obtaining copyright. A
copyright that is purchased is recorded at the price paid
for it
• Copyrights are amortized over their estimated useful
lives
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 25
Copyrights and Trademarks (2 of 2)
• Trademark is a name, term, or symbol used to identify a
business and its products
• Most businesses identify their trademarks with ® in
advertisements and on products
• Trademarks can be registered for 10 years and renewed for
10-year periods thereafter
• Legal costs of registering a trademark are recorded as asset
• If trademark is purchased from another business, its cost is
recorded as an asset and reviewed periodically for impaired
value, at which point a loss would be recorded
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 26
Goodwill
• Goodwill refers to an intangible asset of a business that
is created from such favorable factors as location,
product quality, reputation, and managerial skill
• Generally accepted accounting principles (GAAP) allow
goodwill to be recorded only if objectively determined
by a transaction
• An example is purchase of a business at a price in
excess of fair value of its net assets (assets – liabilities)
• Excess is recorded as goodwill and reported as an
intangible asset
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 27
Financial Reporting for Fixed
Assets and Intangible Assets (1 of 2)
• In the income statement, depreciation and amortization expense should be reported separately or disclosed in a note
• A description of the methods used in computing depreciation should also be reported
• In the balance sheet, each class of fixed assets should be disclosed on the face of the statement or in the notes
• The related accumulated depreciation should also be disclosed, either by class or in total
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 28
Financial Reporting for Fixed
Assets and Intangible Assets (2 of 2)
• Fixed assets may be shown at their book value (cost less
accumulated depreciation)
• If there are many classes of fixed assets, a single amount
may be presented in the balance sheet, supported by a note
with separate listing
• Fixed assets may be reported under more descriptive
caption of property, plant, and equipment
• Intangible assets are usually reported in balance in a separate
section following fixed assets
• Balance of each class of intangible assets should be
disclosed net of any amortization
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 29
Analysis and Interpretation:
Fixed Asset Turnover Ratio• A measure of a company’s efficiency in using its fixed
assets to generate revenue is fixed asset turnover ratio
• Fixed asset turnover ratio measures number of dollars
of sales earned per dollar of fixed assets
• Computed as follows:
• Higher fixed asset turnover, the more efficiently a
company is using its fixed assets in generating sales
Fixed Asset Turnover Ratio =
Sales
Average Book Value of Fixed Assets
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 30
Exchanging Similar
Fixed Assets (1 of 2)
• Old equipment is often traded for new equipment
having a similar use
• Seller allows buyer an amount for old equipment
traded in
• This amount, called the trade-in allowance, may be
greater than or less than book value of the old
equipment
• Remaining balance—the amount owed—is either
paid in cash or recorded as a liability
• It is normally called boot, which is its tax name
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 31
Exchanging Similar
Fixed Assets (2 of 2)
• Accounting for exchange of similar assets depends
on whether transaction has commercial substance
• An exchange has commercial substance if future
cash flows change as a result of exchange
• If an exchange of similar assets has commercial
substance, a gain or loss is recognized
• In such cases, the exchange is accounted for similar
to that of a sale of a fixed asset
©2017 Mr. Breitsprecher & BreitLinks (www.breitlinks.com). All Rights Reserved Slide 32
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