c10 - 1 learning objectives 1.nature of fixed assets 2.accounting for depreciation 3.capital and...
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C10 - 1
Learning Objectives
1. Nature of Fixed Assets2. Accounting for Depreciation3. Capital and Revenue Expenditures4. Disposal of Fixed Assets5. Leasing Fixed Assets6. Internal Control of Fixed Assets7. Natural Resources 8. Intangible Assets9. Financial Reporting10. Financial Analysis and Interpretation
Chapter 10Fixed assets and intangible assets
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LIABILITIES
OWNER’SEQUITY
Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues.
REVENUES
ASSETS
EXPENSES
FixedFixedAssetsAssets
Nature of Fixed AssetsNature of Fixed Assets
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Nature of Fixed AssetsNature of Fixed Assets
LIABILITIES
OWNER’SEQUITY
Fixed assets are long- term, relatively permanent, tangible assets such as buildings and equipment used to help produce revenues.
REVENUES
ASSETS
EXPENSES
FixedFixedAssetsAssets
All fixed assets except land lose their capacityto provide services. This loss of productive capacity is recognized as depreciation expense.
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Costs of Acquiring Fixed Assets Include:Costs of Acquiring Fixed Assets Include:
Sales tax and freight costs
Installation and assembling
Repairs and reconditioning (used assets)
Testing and modifying
Insurance while asset is in transit
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Vandalism
uninsured theft
Mistakes in installation
Damage during unpacking and installing
fines
Costs of Acquiring Fixed Assets Exclude:Costs of Acquiring Fixed Assets Exclude:
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Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense
minus
Initial Cost $24,000a
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equals
Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense
Estimated Residual Value $2,000b
minus
Initial Cost $24,000a
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divided by
Depreciable Cost $22,000
equals
Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense
Estimated Residual Value $2,000b
minus
Initial Cost $24,000a
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equals
Estimated Useful Life 5 yearsc
divided by
Depreciable Cost $22,000
equals
Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense
Estimated Residual Value $2,000b
minus
Initial Cost $24,000a
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Periodic Depreciation Expense $4,400 per year
equals
Estimated Useful Life 5 yearsc
divided by
Depreciable Cost $22,000
equals
Factors that Determine Depreciation ExpenseFactors that Determine Depreciation Expense
Estimated Residual Value $2,000b
minus
Initial Cost $24,000a
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Recording DepreciationRecording Depreciation
General Journal
Description Debit Credit
General Ledger
Equipment 24,000Cash 24,000
Equipment
24,000
AAAA
Accum. Depreciation
Depreciation Expense
Record straight-line depreciation for first year. Record straight-line depreciation for first year.
BB
BB
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
AA
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Record straight-line depreciation for first year. Record straight-line depreciation for first year.
General Journal
Description Debit Credit
General Ledger
Equipment 24,000Cash 24,000
Depreciation Expense 4,400Accum. Depreciation 4,400
Equipment
24,000
AA
BB
AA
Accum. Depreciation
Depreciation Expense
BB
Recording DepreciationRecording Depreciation
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
AA
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Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
AA
Record straight-line depreciation for first year. Record straight-line depreciation for first year.
General Journal
Description Debit Credit
General Ledger
Equipment 24,000Cash 24,000
Depreciation Expense 4,400Accum. Depreciation 4,400
Equipment
24,000
AA
BB
AA
Accum. Depreciation
Depreciation Expense
BB
$24,000 - $2,000
5 years= $4,400
Recording DepreciationRecording Depreciation
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Record straight-line depreciation for first year. Record straight-line depreciation for first year.
General Journal
Description Debit Credit
General Ledger
Equipment 24,000Cash 24,000
Depreciation Expense 4,400Accum. Depreciation 4,400
Equipment
24,000
AA
BB
AA
Accum. Depreciation
4,400 BB
Depreciation Expense
4,400BB
BB
$24,000 - $2,000
5 years= $4,400
Recording DepreciationRecording Depreciation
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
Purchase equipment for $24,000. Estimated residual value is $2,000 and useful life is 5 years.
AA
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General LedgerGeneral Ledger
Equipment
24,000AA
Accum. Depreciation
4,400 BB
Depreciation Expense
4,400BB
Calculation of Book ValueCalculation of Book Value
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General LedgerGeneral Ledger
Calculation of Book ValueCalculation of Book Value
Equipment
24,000AA
Accum. Depreciation
4,400 BB
Depreciation Expense
4,400BB
Original Cost $24,000Less Accum. Depr. 4,400
Book Value 19,600
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The following four depreciation methods are acceptable for Financial Accounting purposes:
1. Straight-Line
2. Units-of-Production
3. Declining-Balance
4. Sum-of-Years-Digits
Straight-lineStraight-line is far more widely used than other methods.
Declining-balance Declining-balance and sum-of-years-digitssum-of-years-digits are known as accelerated depreciation methods.
Depreciation MethodsDepreciation Methods
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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 $24,000.00 $4,400.00 $19,600.00
2 24,000 $ 4,400.00 19,600.00 4,400.00 15,200.00
3 24,000 8,800.00 15,200.00 4,400.00 10,800.00
4 24,000 13,200.00 10,800.00 4,400.00 6,400.00
5 24,000 17,600.00 6,400.00 4,400.00 2,000.00
Straight - Line DepreciationStraight - Line Depreciation
Cost ($24,000) - Residual Value ($2,000)Cost ($24,000) - 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 Rate for Year of Year
1 $24,000 $24,000.00 40% $9,600.00 $14,400.00
2 24,000 $ 9,600.00 14,400.00 40% 5,760.00 8,640.00
3 24,000 15,360.00 8,640.00 40% 3,456.00 5,184.00
4 24,000 18,816.00 5,184.00 40% 2,073.60 3,110.40
5 24,000 20,889.60 3,110.40 –– 1,110.40 2,000.00
Declining - Balance DepreciationDeclining - Balance Depreciation
Note the Note the accelerationacceleration of depreciation of depreciation expense into expense into early years early years of the life of the asset.of the life of the asset.
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Comparing Depreciation MethodsComparing Depreciation Methods
Straight-LineMethod
De
pre
ciat
ion
($
)
10,000
8,000
6,000
4,000
2,000
0Life (years)
Declining-BalanceMethod
Life (years)
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Depreciation for Federal Income Tax-the Modified Accelerated Cost Recovery System (MACRS)
5-year class
Year Rate (%)
1 20
2 32
3 19.2
4 11.5
5 11.5
6 5.8
100%
Why using MACRS
method for both
financial statement and tax purposes
may hurt a business?
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Revising Depreciation Estimates
Example: (P.397)1. Cost : $130,0002. Residual value: $10,0003. Depreciable cost: $120,0004. Useful life: 30 years5. Have Used for ten years6. Net book value: $90,0007. Revise for another 25 years, residual value: $5,0008. Depreciable cost: $85,0009. Revised annual depreciation expense: $3,400
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Capital and Revenue ExpendituresCapital and Revenue Expenditures
EXPENDITURE
Increases operating
efficiency or adds to
capacity?
YesYes
Capital Expenditure
(Debit fixed asset account)
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Capital and Revenue ExpendituresCapital and Revenue Expenditures
EXPENDITURE
Increases operating
efficiency or adds to
capacity?
Increases useful life
(extraordinary repairs)?
NoNo
YesYes
Capital Expenditure
(Debit fixed asset account)
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Capital and Revenue ExpendituresCapital and Revenue Expenditures
EXPENDITURE
Increases operating
efficiency or adds to
capacity?
Increases useful life
(extraordinary repairs)?
NoNo
YesYes
Capital Expenditure
(Debit fixed asset account)
Capital Expenditure
(Debit accumulated
depreciation account)
YesYes
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Revenue Expenditure
(Debit expense account for
ordinary maintenance and repairs)
EXPENDITURE
Increases operating
efficiency or adds to
capacity?
Increases useful life
(extraordinary repairs)?
NoNo NoNo
YesYes
Capital Expenditure
(Debit fixed asset account)
Capital Expenditure
(Debit accumulated
depreciation account)
YesYes
Capital and Revenue ExpendituresCapital and Revenue Expenditures
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LIABILITIES
OWNER’SEQUITY
REVENUES
ASSETS
EXPENSES
Capital and Revenue ExpendituresCapital and Revenue Expenditures
CAPITAL CAPITAL EXPENDITURESEXPENDITURES
1. 1. Initial costInitial cost2. Additions2. Additions3. Betterments3. Betterments4. Extraordinary 4. Extraordinary
repairsrepairs
net income
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LIABILITIES
OWNER’SEQUITY
REVENUES
ASSETS
EXPENSES
Capital and Revenue ExpendituresCapital and Revenue Expenditures
CAPITAL CAPITAL EXPENDITURESEXPENDITURES
Normal and Normal and ordinary repairs ordinary repairs and maintenanceand maintenance
net income
REVENUE REVENUE EXPENDITURESEXPENDITURES
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When fixed assets lose their usefulness they may be disposed of in one of the following ways:
1. discarded,2. sold, or
3. traded (exchanged) for similar assets.
Required entries will vary with type of disposition and circumstances, but the following entries will always be necessary:
Asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove its balance from the ledger.
Accounting for Fixed Asset DisposalsAccounting for Fixed Asset Disposals
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DateDate DescriptionDescription DebitDebit CreditCredit
Discarding Fixed AssetsDiscarding Fixed Assets
Accumulated Depreciation 25,000Equipment 25,000
Loss on Disposal of Equipment 1,100Accumulated Depreciation 4,900
Equipment 6,000
Feb. 14
Write off fully depreciated equipment.
Write off partially depreciated equipment.
Mar. 24
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When fixed assets are sold, the owner may break even, sustain a loss, or realize a gain.
1. If the sale price is equal to book value, there will be no gain or loss.
2. If the sale price is less than book value, there will be a loss equal to the difference.
3. If the sale price is more than book value, there will be a gain equal to the difference.
Gain or loss will be reported in the income statement as Other Income or Other Loss.
Sale of Fixed AssetsSale of Fixed Assets
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Selling Fixed Assets
1. Equipment Cost: $10,000
2. Depreciation rate: 10%/year
3. Depreciation expense: $1,000/year
4. Accumulated depreciation($1000*7): $7,000
5. To be sold on Oct. 12 of the eighth year of its use
6. Current year’s depreciation expense(1-9): $750
7. Book value of the asset: $ 2,250
8. If sold • At book value: $2,250
• Below book value: $1,000, loss $1,250
• Above book value: $2,800, gain $550
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DateDate DescriptionDescription DebitDebit CreditCredit
Sale of Fixed AssetsSale of Fixed Assets
Cash 2,250Accumulated Depreciation 7,750
Equipment 10,000
Oct. 12
Sold at book value, for $2,250.
Sold equipment with a book value of $2,250(cost $10,000, accumulated depreciation $7,750).
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DateDate DescriptionDescription DebitDebit CreditCredit
Sale of Fixed AssetsSale of Fixed Assets
Cash 1,000Loss on Disposal of Equipment 1,250Accumulated Depreciation 7,750
Equipment 10,000
Cash 2,800Accumulated Depreciation 7,750
Equipment 10,000Gain on Disposal of Equipment 550
Oct. 12
Sold below book value, for $1,000.
Sold above book value, for $2,800.
Oct. 12
Sold equipment with a book value of $2,250(cost $10,000, accumulated depreciation $7,750).
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Exchanges of Similar Fixed AssetsExchanges of Similar Fixed Assets
Trade-in Allowance (TIA) – amount allowed for old equipment toward the purchase price of similar new assets.
TIA > Book Value = Gain on Trade TIA < Book Value = Loss on Trade GainsGains are never recognized (not
recorded). LossesLosses must be recognized
(recorded).
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Case One (GAIN)Case One (GAIN)
Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100)
TIA > Book Value = Gain
$1,100 – $800 = $300
Cost of New Equipment
$3,900 + $800 = $4,700
Gains are not recognized for financial reporting.
Exchanges of Similar Fixed AssetsExchanges of Similar Fixed Assets
Quoted price of new equipment acquired $5,000
Cost of old equipment traded in $4,000Accum. depreciation at date of exchange 3,200
Book value at date of exchange $ 800
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Exchanges of Similar Fixed AssetsExchanges of Similar Fixed Assets
Case Two (LOSS)Case Two (LOSS)
Trade-in allowance, $2,000
Cash paid, $8,000 ($10,000 – $2,000)
TIA < Book Value = Loss
$2,000 – $2,400 =- $400
Cost of New Equipment =
Quoted Price of New Asset $10,000
Quoted price of new equipment acquired $10,000
Cost of old equipment traded in $7,000Accum. depreciation at date of exchange 4,600
Book value at date of exchange $ 2,400
Losses are recognized for financial reporting.
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All leases are either capital leases or operating leases. Capital leases include one or more of the following:1. Lease transfers ownership to the lessee at the end of
the lease term.2. An option for a bargain purchase by the lessee.3. Lease term extends over most of the life of the asset.4. Lease requires rental payments that approximate fair
market value of the asset.Capital leases are accounted for as if the lessee has purchased the asset. Lessee debits an asset account for the fair market value and credits a long-term liability.Operating leases are accounted for as rent expense.
Leasing Fixed AssetsLeasing Fixed Assets
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DateDate DescriptionDescription DebitDebit CreditCredit
Natural Resources and DepletionNatural Resources and Depletion
Depletion Expense 36,000Accumulated Depletion 36,000
($400,000 / 1,000,000 tons) = $0.40 per ton90,000 tons x $0.40 = $36,000
Dec. 31
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.
Depletion is the periodic allocation of the cost of metal ores and other minerals removed from the earth.
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DateDate DescriptionDescription DebitDebit CreditCredit
Intangible Assets and AmortizationIntangible Assets and Amortization
Amortization Expense 20,000Patents 20,000
11 years – 6 years = 5-year life ($100,000 / 5 years) = $20,000 per year
Dec. 31
Paid $100,000 for patent rights. The patent life is 11 years and was issued 6 years prior to purchase.
Amortization is the periodic cost expiration of intangible assets which do not have physical attributes and are not held for sale (patents, copyrights, and goodwill).
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Discovery Mining Co.Balance Sheet
December 31, 20--
Accum. BookProperty, 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 Depl. 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 $1,629,000Intangible assets:
Patents $ 75,000Goodwill 50,000 Total intangible assets $125,000
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Discovery Mining Co.Balance Sheet
December 31, 20--
Accum. BookProperty, 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 Depl. 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 $1,629,000Intangible assets:
Patents $ 75,000Goodwill 50,000 Total intangible assets $125,000
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Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities
(in millions)1996 1995
Procter & Gamble
Property, plant, equip. (net) $11,118 $11,026Long-term liabilities (debt) $ 4,670 $5,161
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Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities
(in millions)2000 1999
Procter & Gamble
Property, plant, equip. (net) $11,118 $12,626Long-term liabilities (debt) $ 4,670 $6,231
Use: To indicate the margin of safety to long-term creditors
Use: To indicate the margin of safety to long-term creditors
Ratio of fixed assets toRatio of fixed assets tolong-term liabilitieslong-term liabilities 2.4 2.4 2.0 2.0
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HOME WORK
READING:1. Illustrative problem2. Self- examination questions3. Multiple choice
Writing:1. Exercise: 2. Problem : 10-2A
Discussion: Activity 10-2
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The end of chapter 10