PPT Chapter 10

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Transcript PPT Chapter 10

c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives 1.

2.

3.

4.

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

Compute depreciation, using the following methods: straight-line method, units-of production method, and double-declining balance method.

Journalize entries for the disposal of fixed assets.

Compute depletion and journalize the entry for depletion.

Learning Objectives 5.

Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.

6.

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

7.

Describe and illustrate the fixed asset turnover ratio to assess the efficiency of a company’s use of its fixed assets.

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Nature of Fixed Assets o Fixed assets are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for fixed assets are plant assets or property, plant, and equipment.

Nature of Fixed Assets o Fixed assets have the following characteristics:  They exist physically and, thus, are tangible assets.

 They are owned and used by the company in its normal operations.

 They are not offered for sale as part of normal operations.

N ATURE OF A SSETS F IXED

C LASSIFYING C OSTS

Costs of Acquiring Fixed Assets o Unnecessary costs that do not increase the asset’s usefulness are recorded as an expense.

 Vandalism  Mistakes in installation  Uninsured theft  Damage during unpacking and installing  Fines for not obtaining proper permits from government agencies

Capital and Revenue Expenditures o Expenditures that benefit only the current period are called revenue expenditures .

Capital and Revenue Expenditures o Expenditures that improve the asset or extend its useful life are capital expenditures .

C APITAL AND R EVENUE E XPENDITURES

Revenue Expenditures  Normal and ordinary repairs and maintenance Capital Expenditures  Additions, improvements, and extraordinary repairs

Ordinary Maintenance and Repairs o On April 9, the firm paid $300 for a tune-up of a delivery truck.

revenue expenditure

Asset Improvements o On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo.

capital expenditure

Extraordinary Repairs The engine of a forklift that is near the end of its useful life is overhauled at a cost of $4,500, which extends its useful life by eight years. Work on the forklift was completed on October 14.

capital expenditure

C APITAL AND R EVENUE E XPENDITURES

Leasing Fixed Assets o The two parties to a lease contract are as follows:  The lessor is the party who owns the asset.

 The lessee is the party to whom the rights to use the asset are granted by the lessor.

Leasing Fixed Assets o A capital lease is accounted for as if the lessee has, in fact, purchased the asset. The asset is then amortized (written off as an expense) over the life of the capital lease.

Leasing Fixed Assets o A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease . An operating lease is treated as an expense, because the lessee is renting the asset for the lease term.

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Depreciation o Over time, most fixed assets (equipment, buildings, and land improvements) lose their ability to provide services. The periodic recording of the cost of fixed assets as an expense is called depreciation .

Accounting for Depreciation o Depreciation can be caused by physical or functional factors.

Physical depreciation factors include wear and tear during use or from exposure to the weather.

Functional depreciation factors include obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended.

Accounting for Depreciation o Two common misunderstandings that exist about depreciation as used in accounting include:   Depreciation does not measure a decline in the market value of a fixed asset.

Depreciation does not provide cash to replace fixed assets as they wear out.

Factors in Computing Depreciation o Three factors determine the depreciation expense for a fixed asset. These three factors are:  The asset’s initial cost   The asset’s expected useful life The asset’s estimated residual value

Factors in Computing Depreciation o The expected useful life of a fixed asset is estimated at the time the asset is placed into service. The residual value of a fixed asset at the end of its useful life is also estimated at the time the asset is placed into service.

F ACTORS IN C OMPUTING D EPRECIATION

F ACTORS IN C OMPUTING D EPRECIATION

Straight-Line Method o The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life.

Annual Depreciation = Cost – Residual Value Useful Life

Straight-Line Method  Initial cost: $24,000  Expected useful life 5 years  Estimated residual value: $2,000 o The annual straight-line depreciation of $4,400 is computed below:

Annual Depreciation = = Cost – Residual Value Useful Life $24,000 - $2,000 5 years = $4,400

Straight-Line Method o If the preceding equipment was purchased and placed into service on October 1, the depreciation for the first year of use would be $1,100, computed as follows:

$4,400 x 3/12 = $1,100

Straight-Line Method o The straight-line percentage can be determined by dividing 100% by the number of years of expected useful life, as shown below.

Units-of-Production Method o The units-of-production method provides the same amount of depreciation expense for each unit produced or each unit of capacity used by the asset.

Step 1.

Determine the depreciation per unit as:

Depreciation per Unit = Cost – Residual Value Total Units of Production

Step 2.

Compute the depreciation expense as:

Depreciation Expense = Depreciation per Unit x Total Units of Output Used

Units-of-Production Method o A depreciable asset costs $24,000. Its estimated residual value is $2,000, and it is expected to have a useful life of 10,000 operating hours. During the year, the asset was operated 2,100 hours.

Units-of-Production Method

Double-Declining-Balance Method o The double-declining-balance method provides for a declining periodic expense over the expected useful life of the asset.

Double-Declining-Balance Method o The double-declining-balance method is applied in three steps:  Step 1.

Determine the straight-line percentage using the expected useful life.

 Step 2.

rate by multiplying the straight-line rate from Step 1 by 2.

Determine the double-declining-balance  Step 3.

Compute the depreciation expense by multiplying the double-declining-balance rate from Step 2 times the book value of the asset.

(continued)

Double-Declining-Balance Method o The double-declining-balance rate is determined by doubling the straight-line rate. o A shortcut to determining the straight-line rate is to divide one by the number of years (for example, 1 ÷ 5 = 0.20). o Using the double-declining-balance method, a five-year life results in a 40 percent rate (0.20 × 2).

Double-Declining-Balance Method o For the first year, the book value of the equipment is its initial cost of $24,000. o After the first year, the book value accumulated depreciation) declines and, thus, the depreciation also declines.

(cost minus

Double-Declining-Balance Method o The double-declining-balance depreciation for the full five-year life of the equipment is shown below.

DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE!

STOP

Double-Declining-Balance Method

“Forced” depreciation for 5th year Desired ending book value

Double-Declining-Balance Method o If the preceding equipment was purchased and placed into service on October 1, depreciation for the year ending December 31 would be $2,400, computed as follows:

First year partial depreciation = $9,600 x 3/12 = $2,400

Double-Declining-Balance Method o The depreciation for the second year would then be $8,640, computed as follows:

Second year depreciation = [40% x ($24,000 – $2,400)] Second year depreciation = $8,640

Double-Declining-Balance Method o The double-declining-balance method provides a higher depreciation in the first year of the asset’s use, followed by declining depreciation amounts. Thus, it is called an accelerated depreciation method .

Comparing Depreciation Methods

Comparing Depreciation Methods

Depreciation for Federal Income Tax o The Internal Revenue Code specifies the

Modified Accelerated Cost Recovery System (MACRS)

for use by businesses in computing depreciation for tax purposes.

Depreciation for Federal Income Tax o MACRS specifies eight classes of useful life and depreciation rates for each of the eight classes. The two most common classes are the five-year class (includes automobiles and light-duty trucks) and the seven-year class (includes most machinery and equipment).

Depreciation for Federal Income Tax o For the five-year-class assets, depreciation is spread over six years, as shown below.

Revising Depreciation Estimates o A machine is purchased on January 1, 2013, for $140,000.

Revising Depreciation Estimates o At the end of 2014, the asset’s book value is $88,000, as shown below.

Revising Depreciation Estimates o During 2015, the company estimates that the machine’s remaining useful life is eight years (instead of three) and that its residual value is $8,000 (instead of $10,000). Depreciation expense for each of the remaining eight years is determined as follows:

R EVISING D EPRECIATION E STIMATES

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Discarding Fixed Assets o Equipment acquired at a cost of $25,000 is fully depreciation at December 31, 2013. On February 14, 2014, the equipment is discarded.

Discarding Fixed Assets o Equipment costing $6,000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2013, adjusting entry, Accumulated Depreciation— Equipment has a $4,650 balance. On March 24, 2014, the asset is removed from service and discarded.

Discarding Fixed Assets

$600 × 3/12

Discarding Fixed Assets o The discarding of the equipment is then recorded as shown below. (Note that this is the second of two entries on March 24.)

Selling Fixed Assets o Equipment was purchased at a cost of $10,000. It had no estimated residual value and was depreciated at a straight-line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7,000.

(continued)

Selling Fixed Assets o The entry to update the depreciation for the nine months of the current year is as follows:

(continued)

Selling Fixed Assets o After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

Selling Fixed Assets o After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

Selling Fixed Assets o After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

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Natural Resources o The process of transferring the cost of natural resources to an expense account is called depletion .

Natural Resources  Step 1: Determine the depletion rate as:  Step 2: Multiply the depletion rate by the quantity extracted during the period.

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

Natural Resources o The depletion expense for the year is computed as shown below.

 Step 1.

 Step 2.

Natural Resources o The adjusting entry to record the depletion is shown below.

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Intangible Assets o Patents, copyrights, trademarks, and goodwill are long-lived assets that are used in the operations of a business and not held for sale. These assets are called intangible assets because they do not exist physically.

Intangible Assets o The accounting for intangible assets is similar to that for fixed assets. The major issues are:  Determining the initial cost.

 Determining the amortization , which is the amount of cost to transfer to expense.

Patents o The exclusive right granted by the federal government to produce and sell goods with one or more unique features is called a patent . These rights continue in effect for 20 years.

Patents o At the beginning of its fiscal year, a business acquires patent rights for $100,000. The patent’s remaining useful life is estimated at 5 years. The entry to amortize the patent at the end of the year is as follows:

Patents o Because a patent (as well as other intangible assets) does not exist physically, it is acceptable to credit the asset. This approach is different from physical fixed assets, which require the use of a contra asset account.

Copyrights and Trademarks o The exclusive right granted by the federal government to publish and sell a literary, artistic, or musical composition is called a copyright . A copyright extends for 70 years beyond the author’s death.

Copyrights and Trademarks o A trademark is a unique name, term, or symbol used to identify a business and its products. Most businesses identify their trademarks with ® in their advertisements and on their products. Trademarks can be registered for 10 years and renewed for 10 year periods thereafter.

Goodwill o In business, goodwill refers to an intangible asset of a business that is created from such favorable factors as location, product quality, reputation, and managerial skill.

Goodwill o Generally accepted accounting principles (GAAP) permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction.

Goodwill o A loss should be recorded if the business prospects of an acquired firm (and the acquired goodwill) become significantly impaired. Assume that on December 31, FaceCard Company has determined that $250,000 of the goodwill created from the purchase of Electronic Systems is impaired.

I NTANGIBLE A SSET D ISCLOSURE

C OMPARISON OF I NTANGIBLE A SSETS

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Fixed and Intangible Assets

Fixed and Intangible Assets o o o Intangible assets are usually reported in the balance sheet in a separate section following fixed assets.

The balance of each class of intangible assets should be disclosed net of any amortization.

The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets section of the balance sheet.

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Fixed Asset Turnover Ratio o One measure of the revenue-generating efficiency of fixed assets is the fixed asset turnover ratio . It measures the number of dollars of revenue earned per dollar of fixed assets and is computed as follows:

Fixed Asset Turnover Ratio = Net Sales Average Book Value of Fixed Assets

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Exchanging Similar Fixed Assets o o Old equipment is often traded for new equipment having a similar use. In such cases, the seller allows the buyer a trade-in allowance for the old equipment traded in. The remaining balance—the amount owed—is either paid in cash or recorded as a liability. It is normally called boot .

Gain on Exchange

(see next slide )

Gain on Exchange

Loss on Exchange o This time assume that only a $675 trade-in allowance was allowed toward the purchase of the new equipment. Because the market value of the new equipment is $5,000, the cash paid on the exchange is $4,325.

Loss on Exchange

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