Financial Accounting - Chapter 9: Long-Term Assets: Fixed and Intangible_sc

annual depreciation expense

(initial cost of asset - residual value) / useful life in years

Factors in Computing Depreciation Expense -The asset's initial cost -The asset's expected useful life -The asset's estimated residual value

1. the asset's initial cost- is the purchase price of the asset plus all costs to obtain and ready it for use. For example freight cost and cost of install. 2. the asset's expected useful life- is the estimated length of time the asset will be used in normal operations. An estimate of an asset's useful life is made at the time an asset is placed into service. 3. the asset's estimated residual value- sometimes referred to as scrap value, salvage value, or trade-in value.

Annual Straight-line Depreciation

= Original cost / estimated useful life

Classifying Costs

A cost that has been incurred may be classified as a fixed asset, an investment, or an expense

Units-of-activity method

A depreciation method in which useful life is expressed in terms of the total units of production or use expected from the asset. •The units-of-activity method is applied in the following two steps: -Step 1. Determine the depreciation per unit as follows: Depreciation per unit= Cost - residual value / Total estimated units of activity -Step 2. Compute the depreciation expense as follows: Depreciation Expense = Depreciation per unit x Units of activity for period

accelerated depreciation method

A depreciation method that provides for a higher depreciation amount in the first year of the asset's use, followed by a gradually declining amount of depreciation.

Leasing Fixed Assets

A lease is a contract for the use of an asset for a period of time. Leases are often used in business. For example, automobiles, computers, medical equipment, buildings, and airplanes are often leased. 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.

units-of-production method

A method of depreciation that provides for depreciation expense based on the expected productive capacity of a fixed asset.

straight-line method

A method of depreciation that provides for equal periodic depreciation expense over the estimated life of a fixed asset.

double declining balance method

A method of depreciation that provides periodic depreciation expense based on the declining book value of a fixed asset over its estimated life.

double-declining-balance method

A method of depreciation that provides periodic depreciation expense based on the declining book value of a fixed asset over its estimated life.

trademark

A name, term, or symbol used to identify a business and its products.

copyright

An exclusive right to publish and sell a literary, artistic, or musical composition.

goodwill

An intangible asset that is created from such favorable factors as location, product quality, reputation, and managerial skill.

When the construction is complete, the costs are reclassified by crediting

Construction in Progress and debiting the proper fixed asset account such as Building.

revenue expenditures

Costs that benefit only the current period or costs incurred for normal maintenance and repairs of fixed assets.

• Computing [Straight Line] Depreciation-may be simplified by converting the annual depreciation to a percentage of depreciable cost. • The straight-line deprciation is determined by dividing 100% by the number of years of expected useful life, computed as follows:

EXPECTED YRS. STRAIGHT-LINE OF USEFUL LIFE PERCENTAGE 5 years 20% (100% / 5) 8 years 12.5%(100% / 8) 10 years 10% (100% / 10) 20 years 5%(100% / 25)

example: Kimble inc. purchased equipment for $12,000. Freight cost of 600, installation cost of 1,500 including 500 due to an error in the installation. The journal entry to record the equipment

Equipment(12,500+600+1500-500) 13,600 Cash 13600 The cost of the error in installing the equipment of $ 500 is not included in the cost o the equipment, but instead is recorded as an expense.

patents

Exclusive rights to produce and sell goods with one or more unique features.

Business Expenditures

Investments in business

Penta move company made the following expenditures on one of its delivery trucks. Mar. 20 Replaced the transmission at a cost of $1210 (such a replacement extends the useful life of the truck, Therefore it is a capital expenditure.)Contra asset account June 11. Paid $ 1410 for installing of a hydraulic lift (this is an asset improvement and is categorized as a capital expenditure) To record this, we increase delivery truck as an asset account) Nov. 30 Paid $ 75 to change the oil and air filter (regular expenditure to maintain the asset. Therefore this can be classified as revenue expenditure.) To record this, we increase repaired maintenance expense, an expense account by debiting it for $75 and credit cash for the same amount $75

Journal Date Description Post ref. Debit Credit Mar.20 Accumulated 1210 Depreciation- delivery truck Cash 1210 June 11 Delivery Truck 1410 Cash 1410 Nov. 30 Repairs and Maintenance Expense 75 Cash 75

fixed assets

Long term or relatively permanent tangible assets such as equipment, machinery, and buildings that are used in the normal business operations and that depreciate over time.

intangible assets

Long-term assets that are useful in the operations of a business, are not held for sale, and are without physical qualities.

capital expenditures 2

Major investments in either tangible long-term assets such as land, buildings, and equipment or intangible assets such as patents, trademarks, and copyrights.

Accounting for Depreciation

Over time, fixed assets, with the exception of land, lose their ability to provide services. Thus, the costs of fixed assets such as equipment and buildings should be recorded as an expense over their useful lives. Recording the cost of fixed assets as an expense is called depreciation. Because land has an unlimited life, it is not depreciated.

Investments are long-lived assets that are not used in the normal operation and are held for future resale.

Such assets are reported on the balance sheet in a section entitled Investments.

Items that are classified and recorded as fixed assets include land, buildings, or equipment.

Such assets normally last more than a year and are used in the normal operations.

boot

The amount a buyer owes a seller when a fixed asset is traded in on a similar asset.

trade-in allowance

The amount a seller allows a buyer for a fixed asset that is traded in for a similar asset.

book value

The cost of a fixed asset minus accumulated depreciation on the asset.

capital expenditures

The costs of acquiring fixed assets, adding to a fixed asset, improving a fixed asset, or extending a fixed asset's useful life.

depreciable cost

The difference between a fixed asset's initial cost and its residual value.

Straight line method

The difference between the fixed asset account and its related accumulated depreciation account is called the asset's book value or net book value of the asset. • The book value of the forklift at the end of the first year would be reported on the balance sheet as follows Equipment $ 24,000 Accumulated depreciation (4,400) Book value $19,600

expected useful life

The estimated length of time a fixed asset will be used in normal operations.

residual value

The estimated value of a fixed asset at the end of its useful life.

fixed asset turnover ratio

The number of dollars of sales that are generated from each dollar of average fixed assets during the year, computed by dividing the net sales by the average net fixed assets.

Revenue expenditure

The payment of an operating expense necessary to earn revenue

useful life

The period of time over which an asset contributes to the earnings of a business.

amortization

The periodic transfer of the cost of an intangible asset to expense.

Depreciation Expense

The portion of the cost of a fixed asset that is recorded as an expense each year of its useful life.

depletion expense

The process of transferring the cost of natural resources to an expense account.

initial cost

The purchase price of a fixed asset plus all costs to obtain and ready it for use.

Accumulated Depreciation

The sum of all the depreciation expense recorded to date for a depreciable asset.

depreciation

The systematic periodic transfer of the cost of a fixed asset to an expense account during its expected useful life.

Depreciation can be caused by physical or functional factors. Physical depreciation factors include wear and tear during use or from exposure to 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. For example, equipment may become obsolete due to changing technology. 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. Instead, depreciation is an allocation of a fixed asset's cost to expense over the asset's useful life.

Thus, the book value of a fixed asset (cost less accumulated depreciation) usually does not agree with the asset's market value. This is justified in accounting because a fixed asset is for use in a company's operations rather than for resale. Depreciation does not provide cash to replace fixed assets as they wear out. This misunderstanding may occur because depreciation, unlike most expenses, does not require an outlay of cash when it is recorded.

Only cost necessary for preparing the fixed asset for use are included as a cost of the asset. Unnecessary cost 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.

•Direct costs incurred in the construction of a fixed asset, such as labor and materials, should be capitalized as

a debit to an account entitled Construction in Progress.

fixed assets 2

assets that are relatively permanent, such as land, buildings, and equipment. fixed assets are investments in the business

straight-line method of depreciation

charging an equal amount of depreciation expense for a plant asset in each year of useful life

depreciable cost formula

depreciable cost = cost - estimated residual value

expected useful life of a fixed asset

estimated length of time the asset will be used in normal operations

Cost of Acquiring Fixed Assets or Cost of acquisition

includes the purchase price, taxes, transaction costs (commissions, legal fees, etc.), transportation costs, installation costs, cost of test run (minus income from test run production), decommissioning costs (i.e. costs to be incurred in future to remove the asset), etc. Costs which are not included in the acquisition cost of a fixed asset include the ongoing insurance costs, periodic repair and maintenance costs i.e. such maintenance costs which do not result in improvement...

Expected residual value of an intangible asset:

is the expected value of the asset at the end of its useful life. For most intangible assets, the residual value is zero as many intangible assets are considered worthless once they've been fully utilized.

Physical Depreciation

loss in value resulting from wear and tear

straight-line method 2

provides for the same amount of depreciation expense for each year of the asset's useful life. The annual straight-line depreciation for Exeter's forklift is $4,400, computed as follows: Annual Depreciation= Cost-Residual Value/Useful Life= $24,000-$ 2,000/5 years= $4,400

ordinary maintenance and repairs

represent revenue expenditures. Examples of ordinary maintenance and repair activities include painting, repairing plumbing, adjusting and cleaning equipment, lubricating machines, replacing minor parts, putting in fuel, and so on.

residual value (salvage value)

the amount the company expects to receive from selling the asset at the end of its service life

double declining balance method •The double-declining-balance method is applied in the following three steps: -Step 1. Determine the straight-line percentage, using the expected useful life. -Step 2. Determine the double-declining-balance rate by multiplying the straight-line rate (from Step 1) by 2. -Step 3. Compute the depreciation expense by multiplying the double-declining-balance rate (from Step 2) times the book value of the asset. (For the first year, the book value of the asset is its initial cost.)

•Assume Exeter Company purchased a new forklift on January 1 as follows: Initial cost expected useful life estimated residual value •For the first year, the depreciation is computed as follows: -Step 1. Straight-line percentage = 20% (100% ÷ 5) -Step 2. Double-declining-balance rate = 40% (20% × 2) -Step 3. Depreciation expense = $9,600 ($24,000 × 40%)

Double-Declining-Balance Method (5 of 7)

•In the preceding example, the estimated residual value was $2,000. Therefore, the depreciation for the fifth year is $1,110.40 ($3,110.40 − $2,000.00) instead of $1,244.16 (40% × $3110.40). •The double-declining-balance depreciation for the full five-year life of the equipment is as follows: