What is a fixed asset?

Property, plant and equipment

e.g. Land, buildings, equipment
Intangible assets
e.g. Brands, patents, copyrights
Natural resources
e.g. oil, natural gas, forests

Assets have a useful life greater than one year

Used in operation of a business
Are not intended for resale to customers
Information about long-term acquisitions can be
found under investing activities in the statement
of cash flows
Determining the cost of acquisition of Fixed
Assets
Allocating the cost of Fixed Assets
Accounting for disposal of Fixed Assets

Applying the Matching Rule

When a company purchases an asset, it may
choose
to capitalize it, thus deferring an
period
expense to a later
Favorably impacts profitability for that current period
Management must use ethical judgments when
resolving two issues:
How much of the total cost of a long-term asset 1.
should
period?
be allocated to expense in the current
2. How much should be retained on the balance
sheet as an asset that will benefit future period?
1.
How is the cost of the long-term asset
determined?
How should the expired portion of the cost of the 2.
long-term asset
over time?
be allocated against revenues
3. How should subsequent expenditures, such as
repairs and additions, be treated?
How should disposal of the long-term asset be
recorded?
4.
Issues in Accounting for tong-Term Assets
Property Plant & Equipment
Cost of acquisition
Purchase price
Directly attributable costs
Dismantling and removing
Borrowing costs
Qualifying asset
Conditions
Includes all expenditure reasonable and
necessary to get the asset in place and ready for
use
Include costs of installing and testing a
machine
Property Plant & Equipment
Basket purchases
Fair value
Donated assets
Self-constructed assets
Components of assets

Materials
Labor
Overhead and other indirect costs
Architects' fees
Insurance during construction
Interest on construction loans
Lawyers' fees
Building permits
Outside contractors
Depreciation
The allocation of cost of asset to expense in the
periods in which the services are received from the
asset.
Ba ance Sheet
Assets
P ant and equ pment
ncome Statement
Revenues
Expenses
Deprec at on
Cost of
plant assets
as the services
received
are
Expenses:
:
l
l
ncome Statement
Revenues:
:
Depreciation
Bala
l
nce Sheet
Assets:
:
Plant and equipment
Depreciation is a source of cash
Depreciation is intended to provide funds for
investment.
Depreciation is a valuation process

Depreciation is a process of allocation

Accounting records are not indicators of
changing price levels
As an asset wears out or becomes obsolete,
depreciation must be recorded

1. Cost
-
-
Net purchase price
All reasonable and necessary expenditures to
get the asset in place and ready for use
2. Residual value
- An asset's estimated scrap, salvage, or trade-
in value as of the estimated date of disposal
Also called salvage value or disposal value -
3. Depreciable cost
-
-
Cost less residual value
Depreciable cost is allocated over the useful
life of an asset
4. Estimated useful life
- Total number of service units expected from
a long-term asset
- May be measured in years, miles,
similar measures
units, or

Book Value
=
Cost -Accumulated Depreciation

Accumulated Depreciation
Contra-asset
Represents the portion of assets cost that has already been
allocated to expense.

Causes of Depreciation
- Physical deterioration
- Obsolescence
DEPRECIATION METHOD
Straight-line method
Written-down value method
Production-Unit methods
Under the straight line method, the depreciable
amount of asset is distributed equally over the life of
the asset.
Assumption: depreciation arises solely from the
passage of time.
The yearly depreciation expense is computed by
dividing the depreciable amount (cost of the asset less
its salvage value) by the number of years in the useful
life.
Straight Line Method
Assume that a building costs Rs8,00,000 and is
expected to realize Rs 80,000 at the end of its
estimated useful life of 6 years.
The annual depreciation is calculated as follows:
Depreciation base = cost residual value
= Rs8,00,000 80,000= Rs7,20,000
Annual depreciaion = Rs7,20,000 / 6= Rs. 1,20,000.
How to show in the balance sheet and P&L account?
Depreciation Schedule: Straight Line Method
Year Cost (Rs)
Gross Block
Yearly
Depreciation
(Rs)
Accumulate
d
Deeciation
(Rs)
Ending Book
Value (Rs)
Net Block
1
2
3
4
5
6
8,00,000
8,00,000
8,00,000
8,00,000
8,00,000
8,00,000
1,20,000
1,20,000
1,20,000
1,20,000
1,20,000
1,20,000
1,20,000
2,40,000
3,60,000
4,80,000
6,00,000
7,20,000
6,80,000
5,60,000
4,40,000
3,20,000
2,00,000
80,000
Written-down-value method
(Reducing balance method)
The method provides relatively large amount of
depreciation in the early years of an assets useful life
and smaller amounts in the later years.
In this method, depreciation is computed at a fixed
rate per cent of the book value of the asset at the
beginning of an accounting period.
The depreciation rate can be calculated by using the
following formula:
1- (Residual value / cost )
1/n
, n being the useful life in years
A bus cost Rs8,00,000 and salvage value after 6 years
of useful life is Rs80,000. Thus the depreciation rate is
calculated as follows:
Depreciation rate = 1- (80,000 / 8,00,000)
1/6
= 1- 0.6813
= 0.3187 or 31.87 per cent
Depreciation Schedule: Written-down value method
Ye
ar
Cost
(Rs)
Yearly
depreciation
(Rs)
Accumulate
d
Deeciation
(Rs)
Ending
Book
value
(Rs)
1
2
3
4
5
6
8,00,000
8,00,000
8,00,000
8,00,000
8,00,000
8,00,000
2,54,960
1,73,705
1,18,345
80,629
54,933
37,428
254960
428665
547010
627639
682572
720000
545040
371335
252990
172361
117428
80,000
Production-Unit methods
This method is based on the assumption that
depreciation arises solely from the use of an
asset.
The depreciable amount of an asset is divided
by the total estimated output during its useful
life to obtain the unit depreciation rate.
Yearly depreciation
= unit rate x the yearly output
Production Units Method
If the bus referred to previous example has an
estimated useful life of 2,00,000 Kms.
The unit depreciation is worked out as follows:
Rs7,20,000 / 2,00,000 = Rs3.60 /km
Let us assume that the bus log-book shows that its
usage was as follows:
1
st
year 10,000 km
2
nd
year 30,000 km
3
rd
year 70,000 km
4
th
year 20,000 km
5
th
year 50,000 km
6
th
year 20,000 km
Depreciation Schedule: Production-units method
Ye
ar
Cost Yearly
Depreciatio
n
Accumulated
Depreciation
Ending
book
value
1
2
3
4
5
6
800000
800000
800000
800000
800000
800000
36000
108000
252000
72000
180000
72000
36000
144000
396000
468000
648000
720000
764000
656000
404000
332000
152000
80,000
Special Problems in Depreciation
Accounting
Partial reporting periods
Assets of low value
Revising
useful life and residual value
Changing the depreciation method
Components of an asset
Fully depreciated assets
f the cost of an asset cannot be
recovered through future use or
sa e the asset shou d be
wr tten down to ts net rea zab e
va ue
lf the cost of an asset cannot be
recovered through future use or
sale, the asset should be
written down to its net
realizable value.
Update deprec at on to the
date of d sposa
Record ng cash
rece ved (deb t)
or pa d (cred t)
Remov ng accumu ated
deprec at on (deb t)
Remov ng the asset
cost (cred t)
Journalize disposal by
Recording cash
received (Debit)
or Paid (Credit)
Recording
gain
(credit) or loss
(debit)
asset cost (credit)
.
Removing the
Removing accumulated
depreciation (debit)
Update depreciation to the
date of disposal
f Cash >BV record a ga n (cred t)
f Cash <BV record a oss (deb t)
f Cash =BV no ga n or oss
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
On September 30 2001 A Company sold a machine that
origanally cost $100 000 for $60 000 cash The machine
was placed in service on January 1 1996
It has been depreciated using the stra ght line method with
an estimated salvage value of $20 000 and an estimated
useful life of 10 years
Let s answer the following questions
The amount of deprec at on recorded on
September 30 2001
to br ng deprec at on up to date s
a $8 000
b $6 000
c $4 000
d $2 000
The amount of depreciation recorded on
September 30, 2001,
to bring depreciation up to date is:
a.
.
$8,
,
000.
.
b.
.
$6,
,
000.
.
c.
.
$4,
,
000.
.
d.
.
$2,
,
000.
.
The amount of deprec at on recorded on
September 30 2001
to br ng deprec at on up to date s
a $8 000
b $6 000
c $4 000
d $2 000
(100000-20,000)/10. = 8000 * 9/12
The amount of depreciation recorded on
September 30, 2001,
to bring depreciation up to date is:
a.
.
$8,
,
000.
.
b.
.
$6,
,
000.
.
c.
.
$4,
,
000.
.
d.
.
$2,
,
000.
.
After updat ng the deprec at on the mach ne s
book va ue on September 30
2001 s
a $54 000
b $46 000
c $40 000
d $60 000
After updating the depreciation, the
machine's book value on September 30,
2001, is:
a.
.
$54,
,
000.
.
b.
.
$46,
,
000.
.
c.
.
$40,
,
000.
.
d.
.
$60,
,
000.
.
After updat ng the deprec at on the mach ne s
book va ue on September 30
2001 s
a $54 000
b $46 000
c $40 000
d $60 000
(5 yrs. x $8,000) + $6,000
=
After updating the depreciation, the
machine's book value on September 30,
2001, is:
a.
.
$54,
,
000.
.
b.
.
$46,
,
000.
.
c.
.
$40,
,
000.
.
Cost 100000
Accumulated Depreciation:
Book Value = 54000
d.
.
$60,
,
000.
.
The mach ne s sa e resu ted n
a a ga n of $6 000
b a ga n of $4 000
c a oss of $6 000
d a oss of $4 000
The machine's sale resulted in:
a.
.
a gai
i
n of $6,
,
000.
.
b.
.
a gai
i
n of $4,
,
000.
.
c.
.
a l
l
oss of $6,
,
000.
.
d.
.
a l
l
oss of $4,
,
000.
The mach ne s sa e resu ted n
a a ga n of $6 000
b a ga n of $4 000
c a oss of $6 000
d a oss of $4 000
Cost
Accum. Depr.
$ 100,0
46,000
The machine's sale resulted in:
a.
.
a gai
i
n of $6,
,
000.
.
b.
.
a gai
i
n of $4,
,
000.
.
c.
.
a l
l
oss of $6,
,
000.
.
d.
.
a l
l
oss of $4,
,
000.
.
00
Bookvalue $ 54,000
Cash received 60,000
Gain $ 6,000
Account ng depends on whether
assets are s m ar or d ss m ar
On y s tuat ons where cash
s pa d w be demonstrated
assets are similar or dissimilar.
is paid will be demonstrated.
Only situations where cash
Accounting depends on whether
Cash Paid
Dissimilar Assets
Similar Assets and
Recognize Gains?
Yes No
Recognize
Losses?
Yes Yes
Value Fair value Net Book Value
A company has two automobiles, each originally
costing $20,000, of
has
which $15000 has been
depreciated.
used car.
Each a fair value of $7000 as a
The first car is traded for another automobile with a
list price of $30,000, and $18,000 is given in cash to
the dealer in addition to the trade-in. The cost of
the new car is recorded as $23,000.
The second car is traded for a piece of machine with
a list price of $30,000, and $18,000 is given in cash
to the dealer in addition to the trade-in. Here, the cost
of the new car is recorded as $25,000.

Long-termassets with no physical substance

Have a value based on rights, privileges, or
advantages coming to or belonging to
Accounted for at acquisition cost
the owner

-
-
-
-
-
-
Patents
Copyrights
Leaseholds and leasehold improvements
Franchises
Licenses
Trademarks and brand names and goodwill
Goodwill and trademarks should not appear
on the balance
sheet unless they have been purchased from another party
at a price established in the marketplace.
Accounting issues are similar to other long-
term assets.
Issues include:

-
-
Determining an initial carrying amount
Accounting
amortization
Accounting
for periodic write-off or
- for that amount if the value
declines substantially and permanently
Because of its intangibility, its value and
useful life may be difficult to estimate.
Exists when a purchaser pays more for a business
than the fair market value of the net assets if
purchased separately.
Should be amortized over a reasonable number
future time periods, but not longer than 40 years.
of
Should not be recorded unless it is paid for in
connection with the purchase of a whole business.
Goodwill = Purchase price - FMV of
identifiable assets
A monopoly right granted by govt to an inventor
to make, use, exercise, sell or distribute
exclusively an invention consisting of a new
product or employing new process for 20 years.
Cost is purchase plus legal
cost to defend
.
.If
developed inhouse
capitalize direct cost of
development
.
.
Amortise over
shorter of useful life
or legal life.
A symbo des gn or ogo assoc
ated w th a bus ness
Initial registration
for 10 years but
renewable
indefinitely for
successive
periods of 10
years each.
Amortized over
Useful life.
Record at
cost of
acquisition
.
Internally
developed
trademarks
have no
recorded
asset cost. .
A symbol,
design or logo associated with a
business. Marks or other signs capable of
identifying products/services from a
particular producer
Franchises
Record at lump sum payment to franchiser.
Amortize over period of franchise or license.
Copyright
Record at cost of acquisition. Amortize over
lower of useful or legal life.