11 Fixed Asset - Warren Reeve Depreciation

Chapter 10
Fixed Assets and

Intangible Assets
Accounting, 21st Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division

of Thomson Learning. All rights reserved.
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Objectives
1. Define fixed assets and describe the accounting
for their cost.After studying this
2. Compute depreciation, using the following
chapter, you
methods: straight-line should
method, units-of-
production method, be and
abledeclining-balance
to:
method.
3. Classify fixed asset costs as either capital
expenditures or revenue expenditures.
4. Journalize entries for the disposal of fixed assets.
5. Define a lease and summarize the accounting
rules related to the leasing of fixed assets.
Objectives
6. Describe internal controls over fixed assets.
7. Compute depletion and journalize the entry for
depletion.
8. Describe the accounting for intangible assets,
such as patents, copyrights, and goodwill.
9. Describe how depreciation expense is
reported in an income statement, and prepare
a balance sheet that includes fixed assets and
intangible assets.
10. Compute and interpret the ratio of fixed assets
to long-term debt.
Nature of Fixed Assets
Fixed assets are long term or

relatively permanent assets
Fixed assets are tangible assets
because they exist physically.
They are owned and used by the
business and are not held for sale
as part of normal operations.
Classifying Costs
Is the purchased
item long-lived?
Yes No
Expense
Is the asset used in a
productive purpose?
Yes No
Fixed Assets Investment

Land
• Purchase price
• Sales taxes
• Permits from government
agencies
• Broker’s commissions
• Title fees
• Surveying fees
Land
• Purchase price
• • Delinquent real estate taxes
Sales taxes
• Permits• from
Razing or removing
government
agencies unwanted buildings, less the
• Broker’s salvage
commissions
• Grading and leveling
• Title fees
•
• SurveyingPaving a public street
fees
bordering the land
Buildings
 Architects’ fees
 Engineers’ fees
 Insurance costs incurred
during construction
 Interest on money
borrowed to finance
construction
 Walkways to and
around the building
Buildings
 Sales taxes
 Repairs (purchase of
existing building)
 Reconditioning
(purchase of an existing
building)
 Modifying for use
 Permits from
governmental agencies
Land Improvements
• Trees and shrubs
• Fences
• Parking areas
• Outdoor lighting
• Concrete sewers and drainage
• Paved parking areas
Machinery and Equipment
• Sales taxes
• Freight
• Installation
• Repairs (purchase of used
equipment)
• Reconditioning (purchase
of used equipment)
Machinery and Equipment
• Insurance while in transit
• Assembly
• Modifying for use
• Testing for use
• Permits from
governmental agencies
Cost of Acquiring Fixed Assets Excludes:
 Vandalism
 Mistakes in installation
 Uninsured theft
 Damage during unpacking and installing
 Fines for not obtaining proper permits from
government agencies
Nature of Depreciation
All fixed assets except land lose their capacity
to provide services. This loss of productive
capacity is recognized as Depreciation Expense.
Physical depreciation occurs from wear and tear

while in use and from the action of the weather.
Functional depreciation occurs when a fixed asset is

longer able to provide services at the level for
which it was intended, e.g., personal computer.
Depreciation Expense Factors
Initial Cost - Residual Value = Depreciable Cost
Useful Life
1 2 3 4 5
Periodic Depreciation
Expense
Use of Depreciation Methods
Other Units-of-Production
Declining- 8% 5%
4%
Balance
83%
Straight-Line
Source: Accounting Trends & Techniques, 56th. ed., American Institute of

Certified Public Accountants, New York, 2002.
Facts
Original Cost.....………….. $24,000

Estimated Life in years….. 5 years
Estimated Life in hours….. 10,000
Estimated Residual Value... $2,000
Straight-Line Method
Cost – estimated residual value

Estimated life
= Annual depreciation
$24,000 – $2,000
5 years
= $4,400 annual depreciation
Straight-Line Rate
$24,000 – $2,000
= $4,400
5 years
$4,400
= 18.3%
$24,000
The straight-line method is widely used
by firms because it is simple and it
provides a reasonable transfer of cost to
periodic expenses if the asset is used
about the same from period to period.
Accum. Depr. Book Value Depr. Book Value
at Beginning at Beginning Expense at End
Year Cost of Year of Year for Year of Year
1 $24,000 $24,000 $4,400 $19,600

2 24,000 $ 4,400 19,600 4,400 15,200
3 24,000 8,800 15,200 4,400 10,800
4 24,000 13,200 10,800 4,400 6,400
5 24,000 17,600 6,400 4,400 2,000
Cost ($24,000) – Residual Value ($2,000) Annual

= Depreciation
Estimated Useful Life (5 years) Expense ($4,400)
Units-of-Production Method
Cost – estimated residual value

Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.
$24,000 – $2,000
10,000 hours
= Depreciation perper
= $2.20 unit, hour, etc.
hour
The units-of-production method
is more appropriate than the
straight-line method when the
amount of use of a fixed asset
varies from year to year.
Declining-Balance Method
Step 1
Ignoring residual value,

determine the straight-line rate
$24,000 – $2,000
= $4,800
5 years
$4,800
= 20%
$24,000
There’s a shortcut. Simply
divide one by the number of
years (1 ÷ 5 = .20).
Step 2
Double the straight-line rate.

.20 x 2 = .40
For the first year, the cost of the asset is
multiplied by 40 percent. After the first year,
the declining book value of the asset is
multiplied 40 percent.
Step 3
Build a table.
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600
$24,000 x .40
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760
$14,400 x .40
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
Book Value Accum.
1 STOP!
$24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
If we
Book use this approach in Year
Value 5, we will
Accum.
end the year withAnnual
Beginning a book value of $1,866.
Deprec. Book Value
Year ofRemember,
Year the residual
Rate Deprec. value at the end of
Year-End Year-End
1 Year 5 is40%
$24,000 expected to be $2,000,
$9,600 $9,600so we$14,400
2 14,400 must modify
40% our approach.
5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110
$3,110 – $2,000
Book Value Accum.
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 --- 1,110 22,000 2,000
Desired
ending book
value
Comparing Straight-Line With the
Straight-Line Declining-Balance
Method Method
5,000
Depreciation ($)
4,000
3,000
2,000
1,000
0 1 2 3 4 1 2 3 4
Life (years) Life (years)
Revising Depreciation Estimates
A machine purchased for
$130,000 was originally Annual
estimated to have a useful Depreciation
life of 30 years and a $130,000 – $10,000
residual value of $10,000. 30 years
The asset has been $4,000 per year
depreciated for ten years
using the straight-
line method.
Accumulated
Equipment Depreciation
130,000 4,000
4,000
4,000
4,000
Book value = $90,000 4,000
4,000
4,000
4,000
4,000
Before revising 4,000
40,000
During the eleventh year, it is estimated that the
remaining useful life is 25 years (rather than 20) and
that the revised estimated residual value is $5,000.
Book value – revised residual value

Revised estimated remaining life
$90,000 – $5,000 $3,400 revised
= annual depreciation
25 years
Capital and Revenue Expenditures
Expenditures made to
acquire new plant
assets are known as
capital expenditures.
Expenditures to repair or
maintain plant assets that do
not extend the life or enhance
the value are known as
revenue expenditures.
EXPENDITURE
Revenue
Increases Expenditure
Increases (Debit expense
operating useful life
efficiency or adds No No account for
(extraordinary ordinary
to capacity? repairs)? maintenance
and repairs)
Yes Yes
Capital
Expenditure Capital Expenditure
(Debit fixed asset (Debit accumulated
account) depreciation account)
LIABILITIES
CAPITAL
ASSETS OWNER’S
EXPENDITURES EQUITY
net income
1. Initial cost
2. Additions EXPENSES REVENUES
3. Betterments
4. Extraordinary
repairs
LIABILITIES
ASSETS OWNER’S
EQUITY
net income
REVENUE EXPENSES REVENUES

EXPENDITURES
Normal and
ordinary repairs
and maintenance
Accounting for Fixed Asset Disposals
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:
An asset account must be credited to remove the asset
from the ledger, and the related Accumulated
Depreciation account must be debited to remove it’s
balance from the ledger.
Discarding Fixed Assets
A piece of equipment
acquired at a cost of
$25,000 is fully
depreciation. On
February 14, the
equipment is discarded.
Feb. 14 Accumulated Depr.—Equipment 25 000 00

Equipment 25 000 00
To write off fully depreciated
equipment.
Equipment costing $6,000 is depreciation at an
annual straight-line rate of 10%. After the
adjusting entry, Accumulated Depreciation—
Equipment had a $4,750 balance. The equipment
was discarded on March 24.
Mar. 24 Depreciation Expense.—Equipment 150 00
Accum. Depreciation—Equipment
150 00
To record current depreciation $600 x 3/12
on equipment discarded.
Equipment costing $6,000 is depreciation at an
annual straight-line rate of 10%. After the
adjusting entry, Accumulated Depreciation—
Equipment had a $4,750 balance. The
equipment was discarded on March 24.
Mar. 24 Accumulated Depr.—Equipment 4 900 00

Loss on Disposal of Fixed Asset 1 100 00
Equipment 6 000 00
To write off equipment
discarded.
Sale of Fixed Assets
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.
Equipment costing $10,000 is depreciated at an
annual straight-line rate of 10%. The
equipment is sold for cash on October 12.
Accumulated Depreciation (last adjusted
December 31) has a balance of $7,000.
Oct. 12 Depreciation Expense—Equipment 750 00
Accumulated Depr.—Equipment
750 00
To record current depreciation
$10,000 x ¾
on equipment sold.
x10%
Assumption 1: The equipment is sold
for $2,250, so there is
no gain or loss.
Oct. 12 Cash 2 250 00

Accumulated Depr.—Equipment 7 750 00
Equipment
10 000equipment.
Sold 00
for $1,000, so there is a
loss of $1,250.
Oct. 12 Cash 1 000 00

Loss on Disposal of Fixed Assets 1 250 00
Equipment
10 000equipment.
Sold 00
for $2,800, so there is a
gain of $550.
Oct. 12 Cash 2 800 00

Equipment
10 000 00
Gain on Disposal of Fixed Assets
550
Sold00
equipment.
Exchanges of Similar Fixed Assets
 Trade-in Allowance (TIA) – amount allowed
for old equipment toward the purchase price
of similar new assets.
 Boot – balance owed on new equipment
after trade-in allowance has been deducted.
 TIA > Book Value = Gain on Trade
 TIA < Book Value = Loss on Trade
 Gains are never recognized (not recorded).
 Losses must be recognized (recorded).
List price of new equipment acquired $5,000
Cost of old equipment traded in $4,000
Accum. depreciation at date of exchange 3,200
Book value at date of exchange $ 800
CASE ONE (GAIN):

Trade-in allowance, $1,100
Cash paid, $3,900 ($5,000 – $1,100) Gains are not
TIA > Book Value = Gain recognized for
$1,100 – $800 = $300 financial reporting.
Boot + Book = Cost of New Equipment
$3,900 + $800 = $4,700
On June 19, equipment exchanged

at a gain of $300.
June 19 Accumulated Depr.—Equipment 3 200 00
Equipment (new equipment) 4 700 00
Equipment (old equipment)
4 000 00
Cash
3 900 00
List price of new equipment acquired $10,000
Cost of old equipment traded in $7,000
Accum. depreciation at date of exchange 4,600
Book value at date of exchange $2,400
CASE TWO (LOSS):

Trade-in allowance, $2,000
Cash paid, $8,000 ($10,000 – $2,000)
TIA<Book Value = Loss Losses are
$2,000 – $2,400 = $400 recognized for
financial reporting.
On September 7, equipment
exchanged at a loss of $400.
Sept. 7 Accumulated Depr.—Equipment 4 600 00
Equipment (new equipment) 10 000 00
Loss on Disposal of Fixed Assets 400 00
Equipment (old equipment)
7 000 00
Cash
8 000 00
Natural Resources and
Depletion
Depletion is the process of
transferring the cost of natural
resources to an expense account.
Natural Resources and Depletion
A business paid
$400,000 for the
mining rights to a
mineral deposit
estimated at 1,000,000
tons of ore. The
depletion rate is $0.40
per ton ($400,000 ÷
1,000,000 tons).
Natural Resources and Depletion
During the current year, 90,000 tons are
mined. The periodic depletion is
$36,000 (90,000 tons x $0.40).
Adjusting Entry
Dec. 31 Depletion Expense 36 000 00
Accumulated Depletion
36 000 00
Intangible Assets and Amortization
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).
Date Description Debit Credit

Dec. 31 Amortization Expense 20,000
Patents 20,000
Paid $100,000 for patent rights. The patent life is 11

years and was issued 6 years prior to purchase.
11 years – 6 years = 5-year life
($100,000 / 5 years) = $20,000 per year
Discovery Mining Co.
Partial Balance Sheet
December 31, 2006
Accum. Book
Property, plant, and equipment: Cost Depr. Value
Land $ 30,000 $ 30,000
Buildings 110,000 $ 26,000 84,000
Factory equipment 650,000 192,000 458,000
Office equipment 120,000 13,000 107,000
$910,000 $231,000 $ 679,000
Accum. Book
Mineral deposits: Cost Depr. 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 $1,629,000
Intangible assets:
Patents $ 75,000
Goodwill 50,000
Total intangible assets $ 125,000
Ratio of Fixed Assets to Long-Term Liabilities
Procter & Gamble (in millions)
2002 2001
Fixed assets (net) $13,349 $13,095
Long-term debt $11,201 $9,792
Ratio of fixed assets to
long-term liabilities 1.2 1.3
Use: To indicate the margin of safety
to long-term creditors
Chapter 10
The End

11 Fixed Asset - Warren Reeve Depreciation

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Chapter 10

Fixed Assets and

© Copyright 2004 South-Western, a division

Fixed assets are long term or

Fixed Assets Investment

Physical depreciation occurs from wear and tear

Functional depreciation occurs when a fixed asset is

Initial Cost - Residual Value = Depreciable Cost

Source: Accounting Trends & Techniques, 56th. ed., American Institute of

Original Cost.....………….. $24,000

Cost – estimated residual value

1 $24,000 $24,000 $4,400 $19,600

Cost ($24,000) – Residual Value ($2,000) Annual

Cost – estimated residual value

Ignoring residual value,

Double the straight-line rate.

Book value – revised residual value

REVENUE EXPENSES REVENUES

Feb. 14 Accumulated Depr.—Equipment 25 000 00

Mar. 24 Accumulated Depr.—Equipment 4 900 00

Gain or loss will be reported in the income

Oct. 12 Cash 2 250 00

Oct. 12 Cash 1 000 00

Oct. 12 Cash 2 800 00

CASE ONE (GAIN):

On June 19, equipment exchanged

CASE TWO (LOSS):

Date Description Debit Credit

Paid $100,000 for patent rights. The patent life is 11

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