CHAPTER TWO

FIXED ASSETS AND INTANGIBLE ASSETS

Assets; Lon Term Assets;
1) Current Assets 1) Plant Assets
2) Lon Term Assets 2) Intangible Assets
3) Natural Resources
Section -1: Accounting for Fixed Assets;
2.1 Nature of Fixed Assets;
The term fixed asset is used to indicate;
(1) Plant assets are long term or relatively permanent assets.
(2) Plant assets are tangible assets because they exist physically.
(3) They are owned and used by the business and are not held for sale as part of normal operations.
Plant assets or tangible assets are resources that have three characteristics;
(1) Plant assets they have physical substance (a definite size and shape),
(2) Plant assets are used in the operations of business, and
(3) Plant assets are not intended for sale to customers.
Fixed assets are long-term or relatively permanent assets such as equipment, machinery, buildings, and
land. Fixed assets are also called plant assets or property, plant, and equipment, or plant and equipment.
These assets are expected to provide services to the company for a number of years. In contrast, intangible
assets are assets without a physical feature that can be charged in the operations of business for long period of
time. They generally consist of rights or advantages held such as goodwill, patents, copyrights, franchise,
trademarks, etc. in addition, natural resources are resources that extracted from the earth such as minerals,
oils, (or petroleum), and timber (or lumber).
2.1.1 Classification of Costs of Plant Assets;
A cost that has been incurred may be classified as a fixed asset, an investment, or an expense. The following
table shows how to determine the proper classification of a cost and, thus, how it should be recorded. As
shown in the following table, classifying a cost involves the following steps;
No. Item Purpose Classification
1) Is the purchased item long term? Yes Long term asset
2) Is the purchased item long term? No Expense
3) Is the asset used in a productive purpose? Yes Fixed Asset
4) Is the asset used in a productive purpose? No Investment
Costs that are classified and recorded as fixed assets include the purchase of land, buildings, or equipment.
Such assets normally last more than a year and are used in the normal operations. However, standby equipment
for use during peak periods or when other equipment breaks down is still classified as a fixed asset even
though it is not used very often. In contrast, fixed assets that have been abandoned or are no longer used in
operations are not fixed assets. Investments are long-lived assets that are 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.

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 2.1.2 Determining the Cost of Plant Assets;
The costs of acquiring fixed assets include all amounts spent to get the asset in place and ready for use. For
example, freight costs and the costs of installing equipment are part of the asset’s total cost. The following
table summarizes some of the common costs of acquiring fixed assets. These costs are recorded by debiting the
related fixed asset account, such as Land, Building, Land Improvements, or Machinery and Equipment.
Costs of Acquiring Fixed Assets;

1) Land: is often used as a building site for a manufacturing plant or office site. The acquisition cost of land
includes the negotiated cash price plus other costs such as the cost of land surveys, legal fees, title fees,
broker’s commissions, cost of preparing the land to build on, and even the demolition costs of old
structures that might be torn down to get the land ready for its intended use. Under the historical cost
assumption, land is reported in the balance sheet at its original cost. Land is not subjected to depreciation
because land does not have a limited useful life.
Example-1: Assume Yahoo Company acquires a piece of land for future site on December-1, 2001, by
paying a cash price of Birr 210,000, pays brokerage fees of Birr 7,500 and title fees of Birr 3,000, pays Birr
5,000 to have unwanted building removed, and pays, Birr 1,500 to have the site graded. The business receives
Birr 2,000 salvage from the old building. What is the cost of the land and entry to record its cost?
Number Items Amount
1) Cash prices Birr 210,000
2) Title fees 3,000
3) Brokerage fees 7,500
4) Cost of grading 1,500
5) Cost removing (demolition) unwanted 5,000
6) Less: Salvage (2,000)
Total cost land Birr 225,000
When the acquisition is recorded, Land is debited & Cash is credited for Birr 225, 000.
2) Cost of Buildings: When an existing building is purchased its cost includes, the purchase price plus all
repairs and other expenses required to put it in a usable conditions. On the other hand, when a business
constructs a new building, the cost includes all reasonable and necessary expenditures, such as those for
materials, labor, part of the overhead and other indirect costs, engineers and architects’ fees, insurance
during construction, interest incurred on construction loans during the period of construction, lawyers' fees,

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 and building permits. If outside contractors are used in the construction, the net contract price plus other
expenditures necessary to put the building in usable condition are included.
3) Cost of Equipment: The term ―equipment‖ in accounting includes office equipment, store equipment,
factory equipment, delivery equipment, machinery, furniture and fixtures, and similar fixed assets. The
cost of such assets includes the invoice (purchase) price, transportation and handling charges, insurance on
the equipment while in transit, assembling and installation costs, and costs of conducting trail runs. As
indicated earlier, all costs of getting an asset ready for its intended use are costs of that asset.
Note that: Only costs necessary for preparing the fixed asset for use are included as a cost of the asset.
Unnecessary costs that do not increase the asset’s usefulness are recorded as an expense. For example, the
following costs are included as an expense;
(1) Vandalism,
(2) Mistakes in installation,
(3) Uninsured theft,
(4) Damage during unpacking and installing, and
(5) Fines for not obtaining proper permits from governmental agencies.
2.2 Accounting for Depreciation;
Fixed assets, with the exception of land, lose their ability, over time, to provide services. Thus, the costs of
fixed assets such as equipment and buildings should be recorded as an expense over their useful lives. This
periodic recording of the cost of fixed assets as an expense is called depreciation. Because land has an
unlimited life, it is not depreciated. The 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 the original cost to remain unchanged in the fixed asset account.
Depreciation is the allocation of the cost of a plant asset to expense over its useful (service) life in a rational
and systematic manner. Cost allocation provides for the proper matching of expenses with revenues in
accordance with the matching principle. Depreciation is a process of cost allocation, not a process of asset
valuation.
Depreciation can be caused by physical or functional factors;
(1) Physical depreciation factors include wear and tear during use or from exposure to weather, and
(2) 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.
The two common misunderstandings exist about depreciation as used in accounting include;
(1) 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.

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 This is justified in accounting because a fixed asset is for use in a company’s operations rather than for
resale.
(2) 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.
2.2.1 Factors in Computing Depreciation Expense;
Three factors affect the computation of depreciation;
(1) Cost: is the net purchase price plus all reasonable and necessary expenditures to get the asset in place and
ready for use.
(2) Useful life: is the estimated economic life of an asset in the total number of service units expected from
the asset. Service units may be measured in terms of years the asset is expected to be used, units expected
to be produced, miles or kilometers expected to be driven, or similar measures. In determining the
estimated useful life of an asset, the accountant should consider all relevant information, including (1) past
experience with similar repair assets, (2) the asset’s present condition, (3) the company’s repairs and
maintenance policy, (4) current technological and industry trends, and (5) local conditions such as
whether.
(3) Salvage Value: is also known as residual value, or disposal value, or scrape value, or trade-in value
represents an estimate of the asset’s value at the end of its useful life.
Note that: the difference between the asset cost and its estimated residual value is known as depreciable cost.
2.2.2 Methods of Computing of Depreciation Expense;
Depreciation methods differ primarily in the amount of cost allocated to each period. A list of depreciation
amounts for each year of an asset’s useful life is called depreciation schedule. The most common methods of
computing depreciation for plant assets are;
(1) Straight line method
(2) Units of production method
(3) Double-declining balance method, &
(4) Sum-of- the years-digits method.
1) Straight Line Depreciation Method: When this method is used to allocate depreciation, the depreciable
cost of the asset is spread evenly (uniformly) over the useful life of an asset. The straight-line method is
based on the assumption that depreciation depends only on the passage of time. The depreciation expense
for each period is computed by dividing the depreciable cost by the number of accounting periods in the
asset’s estimated useful life. The straight-line method provides for the same amount of depreciation
expense for each year of the asset’s useful life and it is the most widely used depreciation method.
Example-2: Assume ABC Company acquires on January-1, 2002 new Equipment at a cost of Birr 6,000. It
is estimated that the Equipment has an estimated residual value of Birr 1,000 at the end of its estimated useful
life of 4 years. What is the annual depreciation and depreciation schedule under straight line method?

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 Solution: Annual Depreciation and Depreciation Schedule- Straight-Line Method;
( )

Solution: Depreciation Schedule- Straight-Line Method;

Year Cost Yearly Accumulated Book Value
Depreciation Depreciation
Beginning of first year Birr 6000 - - Birr 6,000
End of first year 6000 Birr 1,250 Birr 1,250 4,750
End of second year 6000 1,250 2,500 3,500
End of third year 6000 1,250 3,750 2,250
End of fourth year Birr 6000 Birr 1,250 Birr 5,000 Birr 1,000
Note that: There are three important points to note from the depreciation schedule for the straight-
line depreciation method; (1) the depreciation is the same each year, (2) the accumulated
depreciation increases uniformly, and (3) the carrying (Book) value decrease uniformly until it
reaches the estimated residual value.
Example-3: Assume Yoon Company purchased Equipment on January-1, 2003 with initial cost Birr 24,000,
expected useful life 5 years and estimated residual value Birr 2,000. What is the annual depreciation and
depreciation schedule under straight-line method?
Solution: Annual Depreciation and Depreciation Schedule- Straight-Line Method;
( )

Solution: Depreciation Schedule- Straight-Line Method;

Year Cost Yearly Accumulated Carrying value
Depreciation Depreciation (Book Value)
Beginning of first year Birr 24,000 - - Birr 24,000
End of first year 24,000 Birr 4,400 Birr 4,400 19,600
End of second year 24,000 4,400 8,800 15,200
End of third year 24,000 4,400 13,200 10,800
End of fourth year 24,000 4,400 17,600 6,400
End of fifth year Birr 24,000 Birr 4,400 Birr 22,000 Birr 2,000
Note that: The computation of straight-line depreciation may be simplified by converting the annual
depreciation to a percentage of depreciable cost. The straight-line percentage is determined by dividing 100%
by the number of years of expected useful life.
Example-4: Assume XYZ Company acquired Equipment on September-1, 2004 at a cost of Birr 125,000 has
an estimated residual value of Birr 5,000 and an estimated useful life of 10 years. What should be; (a) the
depreciable cost, (b) the straight-line rate, (c) the annual straight-line depreciation and (d) the depreciation
schedule using straight line method?
2) Units of Production Method: The production method of depreciation is based on the assumption that
depreciation is mainly the result of use and that the passage of time plays no role in the depreciation
process. When the amount of use of a fixed asset varies from year to year, the units-of-production method
is more appropriate than the straight-line method. In such cases, the units-of-production method better
matches the depreciation expense with the related revenue. The units-of-production method is applied in
two steps;

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 The units-of-production method is applied in two steps.
1) Determine the depreciation per unit as: 2) Compute the depreciation expense as:

(Depreciation Per Unit)X(Total

Units Produced)

Example-5: Assume Tuna Company purchased Equipment on January-1, 2005 with initial cost Birr 24,000,
expected useful life of 10,000 hours and estimated residual value Birr 2,000. Assume that the use of the
Equipment for the first year was 2,800 hours; for the second 3,600 hours; for the third 2,400 hours; and for the
fourth 1,200 hours. What is the depreciation expense and schedule under units of production method?
Solution: Depreciation Per Hour and Depreciation Schedule- Straight-Line Method;
( )

Solution: Depreciation Schedule- Straight-Line Method;

Year Cost Hours Depr/Hour Ann Dep Accum Depr Carrying
value (BV)
Beginning 1st year Birr 24,000 - Birr 2.20 - - Br. 24,000
End of 1st year 24,000 2,800 2.20 Birr 6,160 Br. 6,160 17,840
End of 2nd year 24,000 3,600 2.20 7,920 14,080 9,920
End of 3rd year 24,000 2,400 2.20 5,280 19,360 4,640
End of 4th year Birr 24,000 1,200 Birr 2.20 Birr 2,640 Birr 22,000 Birr 2,000
Example-6: Assume FDF Company acquired Equipment on August-1, 2006 at a cost of Birr 180,000, has an
estimated residual value of Birr 10,000, has an estimated useful life of 40,000 hours, and was operated 3,600
hours during the year. Determine (a) the depreciable cost, (b) the depreciation rate, and (c) the units-of-
production depreciation for the year.
3) Declining Balance Method: This method of depreciation results in relatively large amount of depreciation
in the early years of an assets life and smaller amounts in later years. This method is based on the
assumption of the passage of time. Since most kinds of plant assets are most efficient when new, and so
they provide more and better service in the early years of useful life. It is consistent with the matching
rule to allocate more depreciation to the early years than to later years if the benefits or services received
in the early years are greater. The declining-balance method is the most common accelerated method of
depreciation. Under this method depreciation is computed by applying a fixed rate to the book value of
the asset, resulting in higher depreciation charges during the early years of the asset’s life. Though any
fixed rate might be used under the method, the most common rate is a percentage equal to twice the
straight-line percentage. When twice the straight-line rate is used, the method is usually called the double-
declining balance method. The double-declining-balance method provides for a declining periodic
expense over the expected useful life of the asset. The double-declining-balance method is applied
in three steps. These steps are;
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 two.
Step-3; Compute the depreciation expense by multiplying the double-declining-
balance rate from Step 2 times the book value of the asset

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Example-7: Assume Yonatan Company acquires new Equipment on January-1, 2007 at a cost of Birr
6,000. It is estimated that the Equipment has an estimated residual value of Birr 500 at the end of its estimated
useful life of 4 years. What is the annual depreciation and depreciation schedule under declining method?
Solution: Step-1&3 and Depreciation Schedule, Double-Declining Balance Method
Step-1 Straight Line Percentage (100/4) = 25%
Step-2 Double Declining Balance Rate 25%X2 = 50%
Step-3 Depreciation Expense 50%X6,000 Birr 3,000 for the first year
Solution: Depreciation Schedule, Double-Declining Balance Method
Year Cost Fixed Rate of Yearly Accum Carrying
Depreciation Depreciation Depreciation Value (BV)
Date of purchase Birr 6000 50% - - Birr 6000
st
End of 1 year 6,000 50% Birr 3,000 Birr 3000 3000
End of 2nd year 6,000 50% 1,500 4500 1500
End of 3rd year 6,000 50% 750 5250 750
th
End of 4 year Birr 6,000 50% Birr 250 Birr 550 Birr 500
Note that: The fixed rate of 50% is always applied to the Book Value at the end of the previous year. The
depreciation is greatest in the first year and declines each year after that. Finally, the depreciation in the last
year is limited to the amount necessary to reduce book value to residual value, Birr 250 (Birr 750 – Birr 500,
(that previous book value minus residual value).
Example-8: Assume Marathon Company purchased Equipment on January-1, 2008 with initial cost Birr
24,000, expected useful life of 5 years and estimated residual value Birr 2,000. What is the annual
depreciation and depreciation schedule under declining method?
Solution: Step-1&3 and Depreciation Schedule, Double-Declining Balance Method;
Step-1 Straight Line Percentage (100/4) = 25%
Step-2 Double Declining Balance Rate 25%X2 = 50%
Step-3 Depreciation Expense 50%X6,000 Birr 3,000 for the first year
Solution: Depreciation Schedule, Double-Declining Balance Method;
Year Cost Fixed Rate of Yearly Accum Dep Carrying Value
Depreciation Depreciation (BV)
Date of purchase Birr 24,000 40% - - Birr 24,000
End of 1st year 24,000 40% Birr 9,600 Birr 9,600 14,400
End of 2nd year 24,000 40% 5,760 15,360 8,640
End of 3rd year 24,000 40% 3,456 18,816 5,184
End of 4th year 24,000 40% 2,074 20,890 3110
End of 5th year Birr 24,000 - Birr 1,110 Birr 22,000 Birr 2,000
Example-9: Assume Manna Company acquired Equipment on January-1, 2009 at a cost of Birr 125,000,
has an estimated residual value of Birr 5,000 and an estimated useful life of 10 years. What should be; (a) the
double-declining-balance rate, (b) the double-declining-balance depreciation, and (c) the depreciation
schedule?
4) Sum of Years Digits Method: Like the declining balance method, the sum of the year’s digits method
provides a higher amount of periodic depreciation expense in the earlier use of the asset's life and decline
depreciation expense thereafter because a successively smaller fraction is applied each year to the
depreciable cost of the asset. Under this method, first we must determine the denominator of the fraction,
which is the sum of the digits representing the years of life. While computing depreciation, the
denominator of the fraction is unchanged and would remain the same. On the other hand the numerator of
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 the fraction, decreases year by year (4/10, 3/10/2/10/1/10). At the end of the asset’s useful life, the balance
remaining should be equal to the salvage value. For example, for a plant asset with an estimated life of 4
years, the denominator of the fraction is 4+3+2+1 = 10.
Example-10: Assume ABC Business Enterprise acquires new Machine on June-1, 2010 at a cost of Birr
6,000, and it has an estimated residual value of Birr 500 at the end of its estimated useful life of 4 years. What
is the annual depreciation and depreciation schedule under declining method?
Solution: Depreciation Schedule- Sum - of - the - Years - Digits Method;
Year Depreciable Rate Yearly Accumulated Book Value
Cost Depreciation Depreciation
Date of purchase Birr 6000 - - - Birr 6,000
End of 1st year 6,000 4/10 Birr 2,200 Birr 2,200 3,800
End of 2nd year 6,000 3/10 1,650 3,850 2,150
End of 3rd year 6,000 2/10 1,100 4,950 1,050
End of 4th year Birr 6,000 1/10 Birr 550 Birr 5,500 Birr 500
Note that: The above example for the sum of year’s digit method is based on the assumption that the first use
of the asset coincide with the beginning of the fiscal period. When the first use of the asset does not coincide
with the beginning of a fiscal year, it is necessary to allocate each full year’s depreciation between the two
fiscal years benefited. Assuming that the asset in the example was placed in service after four months of the
fiscal year had been elapsed, the depreciation for that fiscal year would be Birr 1,466.67 computed as follows;
First Year Depreciation 4/10 X (6,000 – 500) X 8/12 Birr 1,466.67
4/10 X (6,000 – 500) X 4/12 Birr 733.33
Second Year Depreciation 3/10 X (6,000 – 500) X 8/12 Birr 1,100 Birr 1,833.33
3/10 X (6,000 – 500) X 4/12 Birr 550
Third Year Depreciation 2/10 X (6,000 – 500) X 8/12 Birr 733.33 Birr 1,283.33

2.2.3 Recording Depreciation Expenses:

The amount by which a fixed asset decreases is an expense of the business. The amount of depreciation
expense should be recorded each fiscal period. If depreciation expense is not recorded, the income statement
will not contain all the expenses of the business. This will cause the net income to be reported higher than it
should be. Income tax laws allow a business to deduct depreciation as an expense in determining net income. If
depreciation expenses are not included on the income tax reports, the business will pay more income taxes than
it should be. Depreciation may be recorded by an entry a t the end of each month, or the adjustment may be
delayed until the end of the year. To record the periodic cost expiration (allocation) of plant asset, the expense
account, depreciation expense is debited and the part of the entry that records the decrease in the plant asset is
credited to a contra asset account entitled Accumulated Depreciation or Allowance for Depreciation. The
use of this contra asset account permits the original cost to remain unchanged in the plant asset account. This
facilitates the computation of periodic depreciation, the listing of both cost and accumulated depreciation on
the balance sheet, and reporting required for property and income tax purposes.
Note that: An exception to the general procedure of recording depreciation monthly or annually is often made
when a plant asset is sold, traded-in, or discarded.

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Example-11: Assume Zebra Company purchased new Machine on January-1, 2011 at cost of Birr 3,000 with
no salvage value and has an estimated economic life of 10 years and the machine was placed in service after
two months had been elapsed in the current period. What would be the journal entry to record the depreciation
expense of the machine, using straight-line method of depreciation?
Solution: Straight Line Method Depreciation Expense;
( )

Date Explanation Debit Credit

Depreciation Expense 250
Accumulated Depreciation Expense – Equipment 250
2.3 Capital and Revenue Expenditures;
Once a fixed asset has been acquired and placed in service, costs may be incurred for ordinary maintenance
and repairs. In addition, costs may be incurred for improving an asset or for extraordinary repairs that extend
the asset’s useful life. Costs that benefit only the current period are called revenue expenditures. Costs that
improve the asset or extend its useful life are capital expenditures. Capital Expenditures are expenditures that
improve the operating efficiency (or capacity) or costs incurred to achieve greater future benefits. In addition
to the acquisition of plant assets, capital expenditures included additions and betterments. Revenue
expenditures are expenditures incurred in order to maintain the normal operating efficiency of the asset.
Among the more usual kinds of revenue expenditures for plant asset are the repairs, maintenance, lubrication,
Cleaning and inspection necessary to keep an asset in good working condition.
Example-12: Assume Artistic Company acquired a machine costing Birr 35,000, had no estimated residual
value and an original estimated useful life of 10 years on January-1, 2001, and has been depreciated for 7
years. The machine was given a major overhaul costing Birr 3,000 as of January-1, 2008 (at the very
beginning of the 8th year). This expenditure extended the useful life of the machine 3 years beyond the original
estimate. What should be the new book value and the entry for the extraordinary repair?
Solution: Journal Entry to Record Extraordinary Repair;
Date Explanation Debit Credit
January-1, 2008 Accumulated Depreciation – Machinery 3,000
Cash 3,000
Solution: Determination of New Book Value;
Items Amounts Amounts
Cost of Machine Birr 35,000
Accumulated Depreciation before extraordinary repair Birr 24,500
Less: Extraordinary repair (Debited to Accum Depr) (3, 000) 21,500
Book value (carrying value) after extraordinary repair Birr 13, 500
Revised Annual periodic depreciation (13,500/6 years) Birr 2, 250

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 2.4 Disposal of Plant Assets;
Fixed assets that are no longer useful may be discarded or sold. In such cases, the fixed asset is removed from
the accounts. Just because a fixed asset is fully depreciated, however, does not mean that it should be removed
from the accounts. If a fixed asset is still being used, its cost and accumulated depreciation should remain in
the ledger even if the asset is fully depreciated. This maintains accountability for the asset in the ledger. If the
asset was removed from the ledger, the accounts would contain no evidence of the continued existence of the
asset. In addition, cost and accumulated depreciation data on such assets are often needed for property tax and
income tax reports. The entry to record the disposal of a fixed asset removes the cost of the asset and its
accumulated depreciation from the accounts. A plant asset may be disposed by;
(1) Discarding it as worthless,
(2) Selling, or
(3) Exchanging (trading) it in on a new asset
1) Discarding Fixed Assets: If a plant asset is of no further use to the business and cannot be sold or traded,
then the plant asset is discarded. If the asset has no book value (if it is fully depreciated), the plant asset
account is credited for the amount of the original cost of the item being discarded. At the same time, the
accumulated depreciation account is debited for the amount of the total accumulated depreciation of the
item being discarded. In this case neither gain nor loss is realized. On the other hand, if a plant asset has a
book value (if not fully depreciated) at the time it is discarded, the business incurs a loss.
Example-13: Assume ABC Company acquired Equipment on July-1, 2012 at a cost of Birr 25,000 and as it
is fully depreciated at August-31, 2016, the Equipment is discarded. What should be the journal entry to
record the discarding of the Equipment?
Solution: Journal Entry to Record Discarding of Equipment;
Date Explanation Debit Credit
August- Accumulated Depreciation – Machinery 25,000
31, 2016 Equipment 25,000
Example-14: Assume Yahoo Company purchased Machine on July-1, 2013 at cost of Birr 11,000 with
estimated useful life of 4 years and estimated salvage value of Birr 2,000. The Machine was discarded as
worthless at the end of its useful life. What should be the entry to record the discarding of the Machine?
Solution: Journal Entry to Record Discarding of Machine;
Date Explanation Debit Credit
August-1, Accumulated Depreciation – Machinery 9,000
2017 Loss on disposal 2,000
Machine 11,000
2) Selling of Fixed Assets: The entry to record the sale of a fixed asset is similar to the entries for discarding
an asset. The only difference is that the receipt of cash is also recorded. If the selling price is more than the
book value of the asset, a gain is recorded. If the selling price is less than the book value, a loss is
recorded. The sale of plant assets should be based on three assumptions about the selling price that; (1)
selling the same with book value, (2) selling above book value, and (3) selling below book value.
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Example-15: Assume Marathon Company acquired Equipment on January-1, 2001 at cost of Birr 10,000
with estimated useful life of 10 years and it is depreciated at an annual straight-line rate of 10%. The
Equipment was sold for cash on September-30, 2008 (that of the eighth year of its use). The balance of the
accumulated depreciation account as of December-31, 2007 was Birr 7,000. What should be the entry to
record the; (1) updated depreciation expense, (2) sale of the asset equal to the Book value, (3) sale of the
Asset for Birr 2,800 and (4) sale of the Asset for Birr 1,000?
Solution:
(1) Record the update depreciation expense;
Date Explanation Debit Credit
September- Depreciation Expense - Equipment 750
30, 2010; Accumulated depreciation – Equipment 750
(To record current depreciation on equipment sold (10,000 X¾ X10%).)
(2) Record the sale of the asset equal to the Book value;
September- Cash 2,250
30, 2010; Accumulated Depreciation – Equipment 7,750
Equipment 10,000
(To record sale of Equipment at Book value, Birr 2,250)
(3) Record the sale of the Asset for Birr 2,800;
September- Cash 2,800
30, 2010; Accumulated Depreciation – Equipment 7,750
Equipment 10,000
Gain 550
(To record sale of Equipment above Book value, Birr 2,800)
(4) Record the sale of the Asset for Birr 1,000;
September- Cash 1,000
30, 2010; Accumulated Depreciation – Equipment 7,750
Loss on sale of Equipment 1,250
Equipment 10,000
(To record sale of Equipment below Book value, Birr 1,000)
Example-16: Assume Wow Fashion Company purchased Machine on January-1, 2005 at cost of Birr
11,000 with estimated useful life of 4 years and estimated salvage value of Birr 2,000. The Machine was sold
on December-31, 2008. What will be the journal entry, if the selling price is; (1) Birr 1,000, (2) Birr 2,000,
and (3) Birr 3,000?
Solution: Journal Entries Under Selling Price of Birr 1,000, Birr 2,000 and Birr 3,000;
Date Explanation Debit Credit
December-31, 2008, if Cash 1,000
sold at Birr 1,000; Accumulated Depreciation – Machine 9,000
Loss on sale of Machine 1,000
Machine 11,000
December-31, 2008, if Cash 2,000
sold at Birr 2,000; Accumulated Depreciation – Machine 9,000
Machine 11,000
December-31, 2008, if Cash 3,000
sold at Birr 3,000; Accumulated Depreciation – Machine 9,000
Machine 11,000
Gain on sale of Machine 1,000

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Example-17: Assume ABC Company acquired Equipment on January-1, 2001 at a cost of Birr 91,000 and
was depreciated using the straight-line method based on with an estimated useful life of nine years and an
estimated residual value of Birr 10,000. Assuming the equipment was sold on December-31, 2003 for Birr
78,000. What should be the entry to record the sale of the Equipment as of December-31, 2003?
3) Exchanging of Fixed Assets: Businesses also dispose of plant assets by trading them in on the purchase of
other plant assets. Exchanges may involve similar assets, such as an old machine traded-in on a newer
model, or dissimilar assets, such as a machine traded-in on a truck. In either case, the purchase price is
reduced by the amount of the trade-in allowance. The basic accounting for exchanges of plant assets is
similar to accounting for sales of plant assets for cash. If the trade-in allowance received is greater than the
carrying value of the assets surrendered, there has been a gain, and if the trade-in allowance is less than the
carrying value, there has been a loss.
There are special rules for recognizing these gains and losses, depending on the nature of the assets
exchanged. These special rules have been presented as follow;
Exchange For Financial Reporting Purposes; Losses Recognized Gains Recognized
1) If Similar Assets Exchanged Yes No
2) If dissimilar Assets Exchanged Yes Yes
Exchange For Income Tax purposes; Losses Recognized Gains Recognized
3) If Similar Assets Exchanged No No
4) If dissimilar Assets Exchanged Yes Yes
Both Gains and Losses are recognized when a company exchanges dissimilar assets. Assets are dissimilar
when they perform different functions; assets are similar when they perform the same function. For financial
reporting purposes, gains on exchanges of similar assets are not recognized because the earning lives of the
asset surrendered are not considered to be completed. When a company trades-in an older machine on a newer
machine of the same type, the economic substance of the transaction is the same as that of a major renovation
and upgrading of the older machine. Accounting for exchange of similar assets is complicated by the fact that
neither gains nor losses are recognized for income tax purposes.
Loss Recognized on the Exchange: A loss is recognized for financial reporting purposes on all
exchange in which a material loss occurs.
Example-18: Assume ABC Company exchanges its old machine with a cost of Birr 11,000, and accumulated
depreciation of Birr 9,000 for a newer more modern machine with Cost of Birr 12,000, and trade-in Allowance
for old machine is Birr 1,500 and cash payment required Birr 10,500 on December-3, 2001. What is the cost
of new Machine and the entry to record the event?
Solution: Determining Cost of New Machine;
Old Machine; New Machine;
Cost of Old Machine Birr 11,000 List Price Birr 12,000
Less: Accumulated Depreciation (9,000) Less: Trade-in Allowance (1,500)
Book Value Birr 2,000 Cash Paid (Boot) Birr 10,500
Cos of New Machine = Cash Paid + Book Value = (10,500 + 2,000) Birr 12,500
Solution: Journal Entry to Record Exchanging of Old Machine by New;

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 Date Explanation Debit Credit
December-3, Equipment (New) 12,000
2001; Accumulated Depreciation 9,000
Loss on exchange 500
Equipment (Old) 11,000
Cash 10,500
Loss Not Recognized on the Exchange: In the previous example (Example-18), in which a loss was
recognized, the new asset was recorded at the purchase price of Birr 12,000 and a loss of Birr 500
was recognized. If the transaction is for similar assets and is to be recorded for income tax purpose, the
loss should not be recognized. In this case, the cost basis of the new asset will reflect the effect of the
unrecorded loss.
Example-19: Assume ABC Company exchanges its old machine with a cost of Birr 11,000, and accumulated
depreciation of Birr 9,000 for a newer more modern machine with Cost of Birr 12,000, and trade-in Allowance
for old machine is Birr 1,500 and cash payment required Birr 10,500 on December-3, 2001. What is the cost
of new Machine and the entry to record the event?
Solution: Determining Cost of New Machine;
Old Machine; New Machine;
Cost of Old Machine Birr 11,000 List Price Birr 12,000
Less: Accumulated Depreciation (9,000) Less: Trade-in Allowance (1,500)
Book Value Birr 2,000 Cash Paid (Boot) Birr 10,500
Cos of New Machine = Cash Paid + Book Value List Price + Loss List Price - Gain
Cos of New Machine = Cash Paid + Book Value = (10,500 + 2,000) Birr 12,500
Solution: Journal Entry to Record Exchanging of Old Machine by New;
Date Explanation Debit Credit
December-3, Equipment (New) 12,500
2001; Accumulated Depreciation 9,000
Equipment (Old) 11,000
Cash 10,500
Gain Recognized on the Exchange: Gains on exchanges are recognized for financial reporting and
income tax purposes when dissimilar assets are exchanged.
Example-20: Assume CMM Company exchanges its old machine with a cost of Birr 4,000, and accumulated
depreciation of Birr 3,200 for a newer more modern machine with Cost of Birr 5,000, and trade-in Allowance
for old machine is Birr 1,100 as of January-10, 2007. What is the cost of new Machine and the entry to record
the event?
Solution: Determining Cost of New Machine;
Old Machine; New Machine;
Cost of Old Machine Birr 4,000 List Price Birr 5,000
Less: Accumulated Depreciation (3,200) Less: Trade-in Allowance (1,100)
Book Value Birr 800 Cash Paid (Boot) Birr 3,900
Cos of New Machine = Cash Paid + Book Value = (3,900 + 800) Birr 4,700
Solution: Journal Entry to Record Exchanging of Old Machine by New;
Date Explanation Debit Credit
January-10, Equipment (New) 5,000
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 2007; Accumulated Depreciation (old) 3,200
Equipment (Old) 4,000
Cash 3,900
Gain 300
Gain Not Recognized on the Exchange: A gain on an exchange should not be recognized in the
accounting records if the assets perform similar functions. The cost basis for the new equipment must
indicate the effect of the unrecorded gain. This cost basis is computed by adding the cash payment to
the carrying value of the old asset.
Example-21: Assume CMM Company exchanges its old machine with a cost of Birr 4,000, and accumulated
depreciation of Birr 3,200 for a newer more modern machine with Cost of Birr 5,000, and trade-in Allowance
for old machine is Birr 1,100 as of January-10, 2008. What is the cost of new Machine and the entry to
record the event?
Solution: Determining Cost of New Machine;
Old Machine; New Machine;
Cost of Old Machine Birr 4,000 List Price Birr 5,000
Less: Accumulated Depreciation (3,200) Less: Trade-in Allowance (1,100)
Book Value Birr 800 Cash Paid (Boot) Birr 3,900
Cos of New Machine = Cash Paid + Book Value = (3,900 + 800) Birr 4,700
Solution: Journal Entry to Record Exchanging of Old Machine by New;
Date Explanation Debit Credit
January-10, Equipment (New) 4,700
2008; Accumulated Depreciation (old) 3,200
Equipment (Old) 4,000
Cash 3,900
Section -2: Accounting for Natural Resources;
2.5 Nature of Natural Resources;
The fixed assets of some companies include timber, metal ores, minerals, or other natural resources. As these
resources are harvested or mined and then sold, a portion of their cost is debited to an expense account. This
process of transferring (periodic cost allocation of these natural resources) the cost of natural resources to an
expense account is called depletion. Natural resources are another group of long-term assets that are
extracted from the earth such as minerals, oils, (or petroleum), and timber (or lumber). The units-of-activity
method is generally used to compute depletion since it is used is that depletion generally is a function of the
units extracted during the year. Under the units-of-activity method, the total cost of the natural resource minus
salvage value is divided by the number of units estimated to be in the resource. The result is a depletion cost
per unit of product. The depletion cost per unit is then multiplied by the number of units extracted and sold.
The result is the annual depletion expense. Depletion differs from depreciation because depletion focuses
specifically on the physical use and exhaustion of the natural resources, while depreciation focuses more
broadly on any reduction of the economic value of a plant or fixed asset. The costs of natural resources are
usually classified as long-terms assets. Unlike plant assets, natural resources are consumed physically over the
period of use and do not maintain their physical characteristics. Depletion is determined as follow;

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 Step-1; Determine the depletion rate as;

Step-2; Multiply the depletion rate by the quantity extracted from the
resource during the period as;

Example-22: Assume ABC Mining Company has acquired the right to use 10,000 acres of land in Humera
territory to mine for gold at a total cost of Birr 10,000,000 on July-15, 2009. The Company estimated that the
mine will provide approximately 500,000 grams of gold, and 100,000 grams were extracted in the first year.
What should be the depletion rate, depletion expense and journal entry?
Solution: Depletion Rate, Depletion Expense and Journal Entry;
( )
Per Gram
Depletion Expense = (Birr 20 X 100,000 Units) Birr 2,000,000
Date Explanation Debit Credit
Depletion Expense 2,000,000
Accumulated Depletion Expense 2,000,000
Example-23: Assume Karst Company purchased mining rights on January-1, 2017 at the cost of mineral
deposit Birr 400,000 and estimated total units of resource 1,000,000 tons. During the year 90,000 tons were
mined. What should be the depletion rate, depletion expense and journal entry?
Solution: Depletion Rate, Depletion Expense and Journal Entry;
( )
Per Tone
Depletion Expense = (Birr 0.4 X 90,000 Units) Birr 36,000
Date Explanation Debit Credit
Depletion Expense 36,000
Accumulated Depletion Expense 36,000
Section -3: Accounting for Intangible Assets;
2.6 Nature of Intangible Assets;
Intangible Assets are rights, privileges, and competitive advantages that result from the ownership of long-
lived assets that do not possess physical substance. Patents, copyrights, trademarks, and goodwill are long-
lived assets that are used in the operations of a business and are not held for sale. These assets are called
intangible assets because they do not exist physically. The evidence of intangibles may exist in the form of
contracts and licenses. They may arise from;
(1) Government grants; such as patents, copyrights, and trademarks.
(2) Acquisition of another business, in which the purchase price includes a payment for the company’s
favorable attributes (called goodwill).
(3) Private monopolistic arrangements arising from contractual agreements such as franchises and
leases.
The accounting for intangible assets is similar to that for fixed assets. The major issues are;
(1) Determining the initial cost, and
(2) Determining the amortization; this is the amount of cost to transfer to expense.

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Intangible Assets are recorded at cost. The cost of an intangible asset should allocate over its useful life,
assuming the useful life is limited. If the life of the intangible is indefinite, the cost of the intangible should not
be allocated. Indefinite means that no legal, regulatory, contractual, competitive, economic, or other factors
limit the intangible’s useful life. Unlike, depreciation for plant assets, the allocation of intangible assets to the
periods they benefits is called amortization. Also, to record amortization of intangible, an amortization
expense is debited and the specific intangible asset is credited (rather than crediting a contra account unlike
in plant asset).
1) Patents: Manufacturers may acquire exclusive rights to produce and sell goods with one or more unique
features. Such rights are granted by patents, which the federal government issues to inventors. These
rights continue in effect for 20 years. A business may purchase patent rights from others, or it may
obtain patents developed by its own research and development. The initial cost of a purchased patent,
including any legal fees, is debited to an asset account. This cost is written off, or amortized, over the
years of the patent’s expected useful life. The expected useful life of a patent may be less than its legal
life. Patent amortization is normally computed using the straight-line method. The 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.
Note that; the patent account is reduced directly by the amount of the amortization expense. This is in contrast
to other long-term asset accounts in which depreciation or depletion is accumulated in a separate contra
account. If the patent becomes worthless before it is fully amortized, the remaining carrying value is written
off as a loss.
Example-24: Assume ABC Company acquires patent rights as of January-1, 2016 for Birr 100,000.
Although the patent will not expire for 14 years, its remaining useful life is estimated as five years. What
should be the journal entry to record purchase of patent and amortization expense of the patent?
Solution: Journal Entry to Record Purchase of Patent;
Date Explanation Debit Credit
Patent 100,000
Cash 100,000
Solution: Journal Entry to Record Patent Expense;
Amortization Expense—Patents 20,000
Patents (100,000/5) 20,000
Example-25: Assume ABC Soft Drink Bottling Company purchased a patent on a unique bottle cap for Birr
54,000 as of January-2, 2002, and it determines that, although the patent for the bottle cap will last for 17
years, the product using the cap will be sold only for the next 6 years. What should be the journal entry to
record the purchase of patent, annual amortization expense and if the patent is expired after two years?
Solution: Journal Entry to Record Purchase of Patent;
Date Explanation Debit Credit
Patent 54,000
Cash 54,000
Solution: Journal Entry to Record Patent Expense;
Amortization Expense—Patents 9,000

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 Patents (54,000/6) 9,000
Solution: Journal Entry to Record Loss of Patent;
Loss on patent 36,000
Patent (54,000-18,000) 36,000
2) 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 allows a business to earn a greater
rate of return than normal. Generally accepted accounting principles (GAAP) allow goodwill to be
recorded only if it is objectively determined by a transaction. An example of such a transaction is the
purchase of a business at a price in excess of the fair value of its net assets (assets-liabilities). The
excess is recorded as goodwill and reported as an intangible asset. Unlike patents and copyrights,
goodwill is not amortized. However, a loss should be recorded if the future prospects of the purchased
firm become impaired. This loss would normally be disclosed in the other expense section of the income
statement.
Example-26: Assume Yonatan Electronics Company determined that Birr 250,000 of the goodwill created
from the purchase of electronic Systems is impaired as of December-31, 2014. What should be the entry to
record the impairment of Goodwill?
Solution: Journal Entry to Record Impairment of Goodwill ;
Date Explanation Debit Credit
Loss from Impaired Goodwill 250,000
Goodwill 250,000
3) Copyrights: The exclusive right to publish and sell a literary, artistic, or musical composition is granted
by a copyright. Copyrights are issued by the federal government and extend for 70 years beyond the
author’s death. The costs of a copyright include all costs of creating the work plus any other costs of
obtaining the copyright. A copyright that is purchased is recorded at the price paid for it. Copyrights are
amortized over their estimated useful lives.
4) Trademarks: A trademark is a 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. Under federal
law, businesses can protect their trademarks by registering them for 10 years and renewing the
registration for 10-year periods. Like a copyright, the legal costs of registering a trademark are recorded
as an asset. If a trademark is purchased from another business, its cost is recorded as an asset. In such
cases, the cost of the trademark is considered to have an indefinite useful life. Thus, trademarks are not
amortized. Instead, trademarks are reviewed periodically for impaired value. When a trademark is
impaired, the trademark should be written down and a loss recognized.
5) Franchise (License): a contractual arrangement under which the franchisor grants the franchisee the right
to sell certain products, provide specific services, or use certain trademarks or trade names, usually
within a designated geographical area.

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The following table summarizes characteristics of intangible assets;
Characteristics of Intangible Assets;

2.7 Presentation of Fixed Assets and Intangible Assets on Balance Sheet;

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. The fixed assets may be shown at
their book value (cost less accumulated depreciation), which can also be described as their net amount. If there
are many classes of fixed assets, a single amount may be presented in the balance sheet, supported by a note
with a separate listing. Fixed assets may be reported under the more descriptive caption of property, plant, and
equipment. 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
Example-27: Assume ABC Company has been presented its fixed assets and intangible assets as follow for
the period of December-31, 2018;
ABC Company; Balance Sheet; December-31, 2018;
Property, plant, and equipment;
Land Birr 1,850,000
Buildings Birr 2,650,000
Less: Accumulated Depreciation (420,000) Birr 2,230,000
Office Equipment Birr 350,000
Less: Accumulated Depreciation (102,000) Birr 248,000
Total Property, plant, and equipment Birr 4,328,000
Intangible Assets;
Patent Birr 140,000
Goodwill Birr 350,000
Total Assets Birr 4,818,000

The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets
section of the balance sheet. The mineral rights may be shown net of depletion on the face of the balance sheet.
In such cases, a supporting note discloses the accumulated depletion.

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