Chapter 7Chapter 7

Fixed Assets and Intangible Fixed Assets and Intangible AssetsAssets

Learning ObjectivesLearning Objectives

After studying this chapter, you should be able to… Define, classify, and account for the cost of fixed assets. Compute depreciation using the straight-line and double-

declining-balance methods. Describe the accounting for the disposal of fixed assets. Describe the accounting for the depletion of natural resources. Describe the accounting for intangible assets. Describe how depreciation expense is reported in an income

statement, and prepare a balance sheet that includes fixed assets and intangible assets.

Learning Objective 1Learning Objective 1

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

Characteristics of Fixed Assets

• They exist physically and thus are tangible assets

• The are owned and used by the company in its normal operations

• They are not offered for sale as part of normal operations

Fixed Assets as a Percentage of Total Assets

Classifying Costs

Costs to Include in Fixed Assets

Costs to Include in Fixed Assets

Revenue and Capital Expenditures

Capital Expenditures• Are asset

improvements• Benefit current and

future periods• Increase fixed assets

Revenue Expenditures• Ordinary repairs and

maintenance• Benefit only the current

period• Increase repairs and

maintenance expense

Revenue and Capital Expenditures

Learning Objective 2Learning Objective 2

Compute depreciation using the straight-line and double-declining-

balance methods

Accounting for Depreciation

• Over time, fixed assets other than land lose their ability to provide services

• The cost of these fixed assets should be expensed in a systematic manner during their useful lives

• This is called depreciation

• Factors include wear and tear

PhysicalPhysicalDepreciationDepreciation

• Factors include obsolescence

FunctionalFunctionalDepreciation Depreciation

Factors in Computing Depreciation Expense

Two Common Depreciation Methods

Asset Asset acquiredacquired

Equal amounts of depreciation each period

Residual Residual valuevalue

• Straight-Line– Same amount of depreciation each year

Straight-LineCost – Estimated Residual ValueCost – Estimated Residual Value

Estimated Useful LifeEstimated Useful Life

Example: Assume a $24,000 depreciable asset with an estimated 5-year useful life and estimated $2,000 residual value.

Annual depreciation expense: ($24,000 - $2,000) / 5 = $4,400

Rate is 1/5 Rate is 1/5 OROR

20% per year20% per year

Asset cost = Asset cost = $24,000$24,000

Depreciation = $4,400 per yearDepreciation = $4,400 per year

Residual value = Residual value = $2,000$2,000

Two Common Depreciation Methods• Straight-Line

• Double-Declining-Balance– Accelerated method that provides more depreciation in

earlier years

Asset Asset acquiredacquired

Depreciation expense larger in earlier periods

Residual Residual valuevalue

Double-Declining-Balance

Double the Straight-Line Rate* Book ValueDouble the Straight-Line Rate* Book Value

Example: Assume a $24,000 depreciable asset with an estimated 5-year useful life and estimated $2,000 residual value.

Residual Residual ValueValue

DoubleDoubleStraight Line Straight Line

RateRate

Comparing Depreciation Methods

Depreciation for Federal Income Tax

• Modified Accelerated Cost Recovery System (MACRS)– Specifies eight classes of useful life and depreciation rates

for each class.– Residual value is ignored.– Fixed assets are assumed to be put in and taken out of

service in the middle of the year.

Five year classFive year class: : light trucks and automobileslight trucks and automobiles

Seven year classSeven year class: : machines and equipmentmachines and equipment

Learning Objective 3Learning Objective 3

Describe the accounting for the disposal of fixed assets

Disposal of Fixed Assets

• Asset can be – Discarded– Sold– Traded

• Book value must be removed from the accounts• Depreciation must be up to date

Discarding Fixed Assets

• Happens when fixed assets are no longer useful to the business and have no market value.

• Assume a $25,000 fixed asset that is fully depreciated is discarded:

Discarding Fixed Assets

• Assume a $6,000 fixed asset with $4,750 of accumulated depreciation on December 31 is discarded in March:

Selling Fixed Assets

• Similar to discarding fixed assets, except that the cash or other asset received must also be recorded

• Could result in gain or loss

Selling Fixed Assets

• Example: Assume that equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The equipment is sold for cash at book value on October 12 of the eighth year of use. Accumulated depreciation at the previous December 31 is $7,000.

Accumulated Depreciation Accumulated Depreciation after adjustment = $7,750after adjustment = $7,750

Book value is now = $2,250Book value is now = $2,250

Selling Fixed Assets #1

• The asset is sold for $2,250

Selling Fixed Assets #2

• The asset is sold for $1,000

Selling Fixed Assets #3

• The asset is sold for $2,800

Learning Objective 4Learning Objective 4

Describe the accounting for depletion of natural resources

Natural Resources

• Natural resources include timber, metal ores, and minerals• As resources are harvested/mined and sold, a portion of the

cost of acquiring them must be expensed• This is called depletion

Calculating Depletion

Depletion = Quantity Extracted × Depletion RateDepletion = Quantity Extracted × Depletion Rate

Depletion Rate = Cost of the Natural ResourceDepletion Rate = Cost of the Natural Resource Estimated Size of the ResourceEstimated Size of the Resource

Depletion Example

• Assume that a business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore.

• Depletion rate = $400,000/1,000,000 = $0.40 per ton• If 90,000 tons are mined during the year, annual depletion is

$36,000

Learning Objective 5Learning Objective 5

Describe the accounting for intangible assets

Intangible Assets

• Long-lived assets lacking physical properties that are useful in the operations of a business and not held for sale; examples include patents, copyrights, trademarks, and goodwill.

• Accounted for similar to fixed assets.• Cost is transferred to expense through amortization.

Types of Intangible Assets

Amortization

• Matching the cost of an intangible asset with its revenue over its useful (legal) life.

• Amortization expense calculation is similar to straight-line depreciation:

AmortizationAmortization = Cost – Estimated Residual Value= Cost – Estimated Residual Value Estimated Useful LifeEstimated Useful Life

Patent Amortization

• Assume a company acquires patent rights for $100,000. The remaining legal life of the patent rights is 14 years, however the company feels the remaining useful life is five years.

Goodwill

• Created from favorable business factors• Only recorded if objectively determined by a transaction• Not amortized – impaired values are adjusted.• Goodwill is the most frequently reported intangible asset.

Intangible Assets

Learning Objective 6Learning Objective 6

Describe how depreciation expense is reported in an income statement,

and prepare a balance sheet that includes fixed assets and intangible assets

Financial Reporting

• Depreciation and amortization should be reported separately

• Description of computations should be disclosed

• Each class of fixed asset should be disclosed

• Related accumulated depreciation should also be reported

Income Income StatementStatement

BalanceBalanceSheetSheet

Financial Reporting

End of Chapter 7End of Chapter 7