17–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus

17–1McQuaig Bille

11College Accounting10th Edition

McQuaig Bille Nobles

© 2011 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Chapter 17Property and Equipment and Intangible Assets

17–2

Initial Costs of Property and Equipment


The original cost of property and equipment includes all normal expenditures necessary to acquire, install, and prepare the property and equipment for its intended use.

Expenditures that result from carelessness, vandalism, and other abnormal causes are not included in the asset’s cost. Such costs should be charged as an expense.

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Ham’s Burgers pays for a refrigerator in cash. The necessary journal entry, in general journal form, is shown below.

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LandLand

Land is the property that is used in the operations of a business.

The cost of land includes the amount paid for the land plus incidental charges connected with the purchase:• Real estate agents’ commissions paid by the

buyer

• Surveying, clearing, draining, or grading the land

• Municipal and county assessment charges

• Razing cost of old buildings on land

17–5

Land ImprovementsLand Improvements

Land improvements–

1) have a determinable or finite useful life or

2) are not directly associated with a building.

Land improvements are recorded in an account by the same title (Land Improvements), thus they are not recorded in the Land account.

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BuildingsBuildings

Buildings is an asset account that includes such items as warehouses, offices, and retail stores. If a building is constructed, the cost of each building includes such items as: Labor and materials

Architectural and engineering fees

Insurance premiums during construction

Interest on loans during the period of construction

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Leasehold ImprovementsLeasehold Improvements

Improvements made to rental property are recorded as leasehold improvements.

The Leasehold Improvements account is an asset used to record improvements in rented property that are made or paid for by the lessee but become the property of the lessor at the end of the lease term.

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EquipmentEquipment

Equipment includes furniture, vehicles, computes, office equipment, and manufacturing machinery.

The Equipment account is a fixed asset. The cost of equipment would include not

only the purchase price but also such items as sales taxes, freight, installation, and assembly.

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Allocation of the Purchase Price Between Land and Building


Ham’s Burgers buys some real property, including land and a building, for $1,600,000. The assessor valued the property for tax purposes at $1,300,000: $700,000 for the land and $600,000 for the building. The allocation is based on the assessor’s valuations.

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STEP 1. Determine the asset percentages based on the assessed value.

Assessed Value of LandTotal Assessed Value =

$700,000$1,300,000

= 53.8%

Assessed Value of BuildingTotal Assessed Value =

$700,000$1,300,000

= 46.2%

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STEP 2. Determine the purchase price allocated to each asset by multiplying the purchase price by the asset percentages.

LANDPurchase price x STEP 1 = $1,600,000 x 53.8% = $860,800

BUILDINGPurchase price x STEP 1 = $1,600,000 x 46.2% = $739,200

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STEP 3. Record the journal entry for the purchase.

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Depreciation, which when used by an accountant means the process of allocating the cost of an asset to an expense over its useful life.

Depreciation represents a systematic procedure for spreading the cost of fixed assets (other than land) over the fiscal periods in which the company receives services from such assets.

The Nature and Recording of Depreciation


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Recording of Depreciation Recording of Depreciation

When Ham’s Burger bought the refrigerator for $3,829, he estimated that it would have a life of five years, and therefore spreads this cost over the five years it is expected to help generate revenue.

Ham’s Burgers depreciates the refrigerator $765.80 per year. The necessary adjusting entry is recorded as follows:

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Accumulated Depreciation is a contra-asset account that is deducted from the related asset account.

Fixed assets are reported on the balance sheet at their book value (or carrying value). Book value is equal to the cost of the asset minus the accumulated depreciation.



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Depreciation Base Depreciation Base

The depreciation base is the full depreciation of an asset.

Depreciation Total Cost of Salvage Value Base an Asset or Trade-in Value= –

Salvage value (or trade-in value) is the expected value of the asset at disposal.

If the salvage value is expected to be insignificant, then a salvage value of zero is assigned to the asset.

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Useful LifeUseful Life

The useful life of an asset is the expected use of the asset.

The length of an asset’s useful life is affected by the amount of physical wear and tear to which it is subjected.

It’s expected length of life is also affected by technological change and innovation.

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Straight-Line MethodStraight-Line Method

A business that uses the straight-line method calculates an equal amount of depreciation expense for each year of service anticipated.

Depreciation per Year

Cost – Salvage ValueUseful Life (in years)=

The percentage rate of depreciation per year is determined by dividing the number of years of useful life into 1.

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Straight-Line MethodStraight-Line Method

Ham’s Burgers purchases a new 65-lb. capacity fryer costing $10,500 and having a useful life of five years. The estimated salvage value at the end of five years is $1,000.

Depreciation per Year

Cost – Salvage ValueUseful Life (in years)

=$10,500 – $1,000

5

= $1,900

OR: 1 ÷ 5 = 20.0% x ($10,500 – $1,000) = $1,900

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Double-Declining-Balance MethodDouble-Declining-Balance Method

The double-declining-balance method is an accelerated method of depreciation that allows larger amounts of depreciation to be taken in the early years of an asset’s life.

Salvage value is not used in determining depreciation by the double-declining-balance method until the end of the depreciation schedule.

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STEP 1. Calculate the straight-line depreciation rate.

Straight-Line Depreciation Rate =1

Useful Life

STEP 2. Multiply the straight-line rate by 2.

STEP 1 × 2

STEP 3. Multiply the book value of the asset at the beginning of the year by double the straight-line rate. Depreciation Expense per Year = Book Value at Beginning of Year × STEP 2


STEP 4. Do not depreciate below salvage value. The amount of depreciation can only reduce book value to salvage value.

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Compute the straight-line depreciation rate. Straight-Line 1Depreciation Rate 5 years=

Straight-Line Depreciation Rate = .020 x 100% = 20%


STEP 1.

EXAMPLE: Ham’s Burgers purchases a new 65-lb. capacity fryer for $10,500, with a useful life of five years. The estimated salvage value at the end of five years is $1,000.

STEP 2. Multiply the straight-line rate by 2.

0.20 x 2 = 0.40 OR 20% x 2 = 40%

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Depreciation Expense per Year = Book Value at Beginning of Year x 0.40 (or 40%)


STEP 3.

*rounded

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Notice that in year 5 the depreciation expense stops at $1,000 because ending book value cannot go below the salvage value. The amount of depreciation for year 5 is determined by subtracting the salvage value of $1,000 from the book value of the fryer at the end of Year 4 ($1,361).


STEP 4.

Observe carefully that the salvage (or trade-in) value is not used until the fifth year.

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Units-of-Production MethodUnits-of-Production Method

A salesperson’s car cost $24,000 and has a useful life of 60,000 miles. The estimated salvage value at the end of 60,000 miles is $7,200. The car is driven 18,500 this year and 20,000 miles next year.

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Calculate the depreciation per unit.

Depreciation per Unit = Cost – Salvage ValueEstimated Units of Production

Depreciation per Unit = $24,000 – $7,200 60,000 miles

Depreciation per Unit = $0.28 per mile


STEP 1.

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Multiply the depreciation per unit by the number of units produced.

Depreciation Expense per Year

Step 1 x Number of Units Produced

=

Depreciation Expense for 18,500 Miles $0.28 x 18,500 = $5,180=

Depreciation Expense for 20,000 Miles $0.28 x 20,000 = $5,600=


STEP 2.

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Depreciation for Periods of Less Than a Year


Computed from May 1

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Computed from November 1

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Modified Accelerated Cost Recovery System (MACRS)Modified Accelerated Cost

Recovery System (MACRS)

For property acquired after 1986, a schedule of depreciation called the Modified Accelerated Cost Recovery System (MACRS) has been established.

Under MACRS, assets are divided into classes.

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MACRS Property Classes

17–32


Recovery System (MACRS) The following chart provides the percentage of cost

allocation (written off or depreciated) each year for three-year, five-year, and seven-year property.

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Ham’s Burgers purchases a new fixture (classified as seven-year property) having a cost of $300.

Determine into which of the eight classes the asset falls.

The new fixture falls in the seven-year property category.

STEP 1.

STEP 2. Consult the schedule to determine the percentage figure for each year.

The percentage for the first year is 14.29%.

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Multiply the cost of the asset by the percentage figure.

Depreciation Expense for Year 1 = $300 x 0.1429 = $42.87

Depreciation Expense for Year 2 = $300 x 0.2449 = $73.47

STEP 3.

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Capital ExpendituresCapital Expenditures

Capital expenditures include the initial costs debited to property and equipment; they also include any costs of enlarging or increasing the capacity of assets.

Ham’s Burgers spends $20,000 to modify an existing fast-food restaurant by enlarging it.

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Revenue ExpendituresRevenue Expenditures

Revenue expenditures include the costs of maintaining the operation of an asset, such as the expense of making normal repairs.

Ham’s Burgers spent $350 repairing the plumbing in an existing fast-food restaurant.

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Extraordinary-Repairs Expenditures


Extraordinary-repairs expenditures refer to a major overhaul or reconditioning that either extends the useful life of an asset beyond its original estimated life or increases the estimated trade-in value.

Example: On January 3, Year 1, Ham’s Burgers bought a used truck for $18,000. The truck’s estimated useful life is four years and its trade-in value is $5,000.

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Straight-line annual depreciation expense is $3,100. On January 5, Year 4, Ham’s Burger puts in a new engine and has other major repairs done, for which it spends $3,480 in cash.

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The extraordinary repair extends the life of the truck from the present one additional year to three additional years.

+ –Truck

Jan. 3, Year 1

18,000Jan. 5, Year 4

3,480

17–40

The truck’s book value before the extraordinary repair was $8,700 ($18,000 – $9,300). After the extraordinary repair it is $12,180 ($18,000 – $3,480 – $9,300).



17–41

Recalculating DepreciationRecalculating Depreciation

New book value ($21,480 – $9,300) $12,180Less trade-in value (assumed the same) 5,600New depreciation base $ 6,580

Depreciation expense = $6,580 ÷ 3 = $2,193**rounded

The adjusting entry for depreciation of the truck at the end of Year 4 is as follows:

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Step 1. Record the entry to depreciate the asset up to date, if applicable.

Step 2. Calculate the book value.

Step 3. Determine the gain or loss.

Step 4. Record the entry to discard or sell the asset.

Discarding or Retiring Property and EquipmentDiscarding or Retiring

Property and Equipment

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A display case that originally cost $1,760, with a zero salvage value, and that has been fully depreciated is given away as junk.



17–44

No entry is required because the asset is fully depreciated.



STEP 1.

Once an asset is fully depreciated, the asset’s book value remains at its estimated salvage value unless an extraordinary repair is made or the company disposes of the asset.

STEP 2.

Book Value = $1,760 – $1,760 = $0

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If an asset is fully depreciated and the company does not receive any cash for discarding the asset, there is no gain or loss recognized.

STEP 3.

STEP 4. A journal entry is made to record disposal of the display case.

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Discarding an Asset Not Fully Depreciated


On August 12, Ham’s Burgers discards a printer that originally cost $1,720. No salvage value is recognized. Accumulated Depreciation up to the end of the previous year is $1,032. Depreciation for the current year through August 12 is $352.

Accumulated Depreciation, Office Equipment

Bal.

$1,032

352

1,384

– +

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Record the entry to depreciate the printer up to date.STEP 1.

Bal.

$1,032

352

1,384

– +

Accumulated Depreciation, Office Equipment

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Calculate the book value.

Book Value = $1,720 – $1,384 = $336

STEP 2.



STEP 3. Because the firm realized nothing from the disposal of the asset, the loss is for the same amount as the book value.

Loss = $0 – $336 = $(336)

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Record the journal entry for the disposal of the printer.

STEP 4.

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Sale of an Asset at a LossSale of an Asset at a LossOn August 21, Ham’s Burgers sells a kitchen range for $150, which originally cost $2,100; accumulated depreciation to the end of the previous year (December 31) was $1,680. Yearly depreciation is $210.

STEP 1. Record the entry to depreciate the kitchen range up to date.

After posting the journal entry, the Accumulated Depreciation, Equipment account will have a balance of $1,820.

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Sale of an Asset at a LossSale of an Asset at a Loss

Calculate the book value.

Book Value = $2,100 – $1,820 = $280

STEP 2.

STEP 3. Determine the gain or loss.

Loss = $150 – $280 = $(130)

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Sale of an Asset at a LossSale of an Asset at a Loss

The entry to record the sale of the kitchen range is shown in general journal form.

STEP 4.

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Sale of an Asset at a GainSale of an Asset at a GainOn October 18, Ham’s Burgers sells a dishwasher for $400 for which it originally paid $4,400; accumulated depreciation is $3,900. Yearly depreciation is $360.

Record the entry to depreciate the dishwasher up to date.

STEP 1.

After the above entry, Accumulated Depreciation, Equipment has a balance of $4,260.

17–54

Sale of an Asset at a GainSale of an Asset at a Gain

Calculate the book value.STEP 2.

STEP 3. Determine the gain or loss.

Gain = $400 – $140 = $260

Book Value = $4,400 – $4,260 = $140

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Sale of an Asset at a GainSale of an Asset at a Gain

The entry, in general journal form, to record the sale of the dishwasher is as follows:

STEP 4.

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Exchange of Long-Lived Assets for Other Similar Assets

Exchange of Long-Lived Assets for Other Similar Assets

A gain on an exchange of this nature results when the market (or trade-in allowance) is greater than the book value.

A loss on an exchange of this nature results when the market (or trade-in allowance) is less than the book value.

Gains and losses are record for GAAP purposes; however, federal income tax laws require no gain or loss to be recognized.

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Exchange When Trade-In Value Is Greater Than Book Value

Exchange When Trade-In Value Is Greater Than Book Value

Ham’s Burgers bought a copier for $2,600. After some years, Ham’s Burgers decides to trade it in on a new model. The old copier has accumulated depreciation of $2,480 on the date of the trade-in, leaving a book value of $120 ($2,600 – $2,480). The new copier has a list price of $3,350. Ham’s Burgers is allowed a trade in allowance of $310; the difference is paid in cash.

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Debit Office Equipment (new) for its list price.

Close Accumulated Depreciation, Office Equipment for the accumulated depreciation on the old equipment.

Calculate the gain ($310 – $120) = $190 and credit the gain account.

Credit Cash, $3,040 (quoted price of the new copier $3,350, minus the $310 trade-in allowance).

Remove the cost of the old office equipment from the ledger.

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Exchange When Trade-In Value Is Less Than Book Value

Exchange When Trade-In Value Is Less Than Book Value

Ham’s Burgers bought a delivery truck for $30,400. Four years later, the truck has accumulated depreciation of $26,200 (book value = $30,400 – $26,200 = $4,200). Ham’s Burgers buys a new truck, with a list price of $35,400, trading in the old one, for which the company is allowed $2,800, and paying the difference in cash. The depreciation is up to date.

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List price of new delivery truck.

Accumulated Depreciation, Delivery Equipment is debited to remove accumulated depreciation related to old delivery truck.

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The loss is determined as follows: $2,800 – $4,200 = $(1,400).

Credit Cash, $32,600 (quoted price of the new truck , $35,400, minus the $2,800 trade-in allowance).

The cost of the old delivery truck is removed from the ledger.

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Subsidiary ledgers can be used when recording property and equipment. For example, the Store Equipment account represents a functional group; it includes all types of equipment used in a store.

Property and Equipment Records


When using subsidiary ledgers, Store Equipment is a controlling account; the property and equipment ledger is a subsidiary ledger.

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Intangible AssetsIntangible AssetsIntangible assets are assets that are purchased for use in the business and have a useful life longer than one year but have no physical substance. A patent is an exclusive right to sell or produce an

invention. A copyright is an exclusive right of protection to

creators of artistic works. A trademark represents a word, slogan, or symbol

that identifies a company or product. A franchise is an exclusive right to use a company’s

name and to sell its products. Goodwill represents the value of the business over

its identified assets. It must be determined by the purchase price.

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Intangible AssetsIntangible Assets

On December 31, the following entry would be made:

On January 1, Ham’s Burgers purchases a patent costing $20,000 with a useful life of 10 years. Ham’s Burgers pays for the patent in cash

Documents

17–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus