Chapter 10 Long Term Assets

 

Long Term Assets—Assets having lives of two years or longer.

 

Expensing long term assets—the cost of a long term asset is spread over a period of time

 

            Type of long term asset             Expense

Physical (tangible assets)—Examples:  Equipment, buildings, automobiles, assets recorded from capital leases

 

Depreciation expense—recorded over the estimated life of the physical asset.  Land is not depreciated because it has an indeterminate life.

 

Intangible assets—Examples:  Patents, Copyrights, Goodwill

 

Amortization expense—recorded over the life of the intangible asset (except goodwill is not amortized)

 

Natural resources—Example minerals

 

Depletion expense—recorded over the extraction period

 

Capitalize—record as an asset (instead of an expense)

Repair expenditures that extend an asset’s life are capitalized, recorded as an asset.

 

Goodwill—an intangible asset recorded when a business is purchased for a price that exceeds the fair market value of the physical assets in the business being purchased.

The purchase price would be allocated (debited) to the physical assets with the remainder to the asset account goodwill.  The goodwill account is reviewed each year for appropriate valuation (impairment valuation).  It is not amortized like the other intangible asset accounts.

 

Research and development expenditures—expensed (not capitalized)

 

DEPRECIATION

Goals

  • Review depreciation methods
  • Record simple cash sales of depreciable assets

 

 

Depreciation expense

$xxx

 

          Accumulated depreciation

 

$xxx

To record depreciation expense

 

 

 

Contra account—offsetting account

Accumulated depreciation—a contra account offsetting the asset being depreciated

 

Book value—(same as carrying value and financial statement value) an account netted with its contra account

 

Salvage value (same as residual value)—estimated value of an asset at the end of its accounting life.

 

In all methods of depreciation, the book value of the depreciable asset will not fall below salvage value.

 

Accelerated depreciation method—A depreciation method where recorded depreciation expense in early years is greater than what is recorded in later years.  Revenue less expenses equals net income.  A goal of recording a large expense amount would be to show a reduced net (taxable) income.

 

Depreciation Methods (practiced here)

  1. Straight line method
  2. Double declining balance method—an accelerated method
  3. Sum of years’ digits method—an accelerated method

Example:  An asset costs $10,000.  It has an accounting life of 5 years.  Its salvage value is $200.

Required:  Compute depreciation expense and book value using each of the methods.

 
 
 

 

 

 

 

 

 


  1. Straight-line method—An asset is depreciated evenly over its accounting life.

 

            Annual depreciation expense =   (Cost – SV)

                                                                    Life

Year

Straight Line Method

 

 

Depreciation expense

Accumulated Depreciation Balance

Book value or carrying value

(Cost – Accumulated)

1

$1,960

$1,960

$8,040

2

$1,960

$3,920

$6,080

3

$1,960

$5,880

$4,120

4

$1,960

$7,840

$2,160

5

$1,960

$9,800

$200

Total

$9,800

 

 

 

 

  1. Double Declining Balance—
  • Depreciation expense = Carrying value x (2 times faux straight line rate)
  • In the last/later year/s, depreciation expense is plugged so that carrying value is equal to salvage value

 

Year

Carrying Value

 

 

(Cost –Acc)

2 * Faux SL rate

 

(2 x 20%)

Double declining balance method

Depreciation Expense

(CV * DDB rate)

Accumulated Depreciation Balance

 

 

1

$10,000

40%

$4,000

$4,000

2

$6,000

40%

$2,400

$6,400

3

$3,600

40%

$1,440

$7,840

4

$2,160

40%

$864

$8,704

5

$1,296

Plug

$1,096

$9,800

Total

$200

 

 

 

 

Examples:  Computing Double Declining Balance Rate

Years in Acccounting Life

 

SL rate

 

DDB rate

 

10

 

10%

 

20%

 

8

 

13%

 

25%

 

6

 

17%

 

33%

 

5

 

20%

 

40%

 

4

 

25%

 

50%

 

3

 

33%

 

67%

 

 

  1. Sum of Years’ Digits Method
  • An accelerated method
  • Depreciation expense = (Cost – SV) * fraction
  • Denominator in fraction is (S years)

 

Denominator in example = 5 + 4 + 3 + 2 + 1 = 15

Year

Depreciable Cost

(Cost – SV)

Fraction

Sum of Years’ Digits

Depeciation Expense

(Cost – SV) * Fraction

Accumulated Depreciation Balance

 

 

1

$9,800

5/15

$3,267

$3,267

2

$9,800

4/15

$2,613

$5,880

3

$9,800

3/15

$1,960

$7,840

4

$9,800

2/15

$1,307

$9,147

5

$9,800

1/15

$653

$9,800

Total

 

 

 

 

Examples:  Computing Denominator in Sum of the Years’

 

 

 

 

 

 

 

 

 

 

Years

 

 

 

 

 

Denominator

10

 

10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 =

55

 

7

 

7 + 6 + 5 + 4 + 3 + 2 + 1 =

 

28

 

5

 

5 + 4 + 3 + 2 + 1 =

 

 

15

 

4

 

4 + 3 + 2 + 1 =

 

 

10

 

3

 

3 + 2 + 1 =

 

 

6

 

 

Depreciation is recorded over time.  If an asset is purchased mid-year or sold mid-year, a partial year of depreciation would be recorded (not the full year).  The amount of depreciation recorded in the accounts affects the size of subsequent gains and losses on disposal.

 

Cash Sales of Depreciable Assets

In cash sales of depreciable assets, there is full recognition of gains and losses.  In this beginning accounting course, we will practice recording cash sales of depreciable assets.

 

Gain on Sale—Revenue account recorded when cash received in the sale is more than the book value of the asset sold

 

Loss on Sale—Expense account recorded when cash received in the sale is less than the book value of the asset sold

 

 

Examples:  Assume that depreciation expense has been recorded for the time period up to the sale.

  1. Equipment costing $15,000 with accumulated depreciation of $4,500 is sold for $18,000 cash.
  2. Equipment costing $5,000 with accumulated depreciation of $3,000 is sold for $1,200 cash.
 
                                                                                                                                                                                                                                                           

 

 

 

 

 

 

 

 

 

 

1.  Cash

18,000

 

     Accumulated Depreciation

 4,500

 

                Equipment

 

15,000

                Gain on Sale

 

7,500

To record cash received and remove equipment and its contra account

 

 

 

 

 

 

 

 

 

2.  Cash

1,200

 

      Accumulated Depreciation

3,000

 

      Loss on Sale

800

 

                 Equipment

 

5,000

To record cash received and remove equipment with its contra

 

 

 

 

 

 

 

Land— not is not depreciated.  It cannot be assigned an accounting life.

 

Problem One  Equipment costs $5,000.  It has a salvage value of $100.  Its accounting life is 4 years.  Prepare a depreciation schedule showing depreciation expense for each of the years using each of the following methods.

    1. Straight Line Method
    2. Double Declining Balance Method
    3. Sum of Years’ Digits Method

 

Problem Two  Equipment costs $20,000.  It has a salvage value is $2,000.  Its accounting life is 5 years.   Prepare a depreciation schedule showing depreciation expense for each of the years using each of the following methods.

    1. Straight Line Method
    2. Double Declining Balance Method
    3. Sum of Years’ Digits Method

 

Problem Three  For the following assets, assume that depreciation has been recorded for the time prior to the sale.  Make journal entries to record each of the following cash sales.

  1. Equipment costing $4,000 with accumulated depreciation of $3,000 is sold for $5,100 cash.
  2. An automobile costing $10,000 with accumulated depreciation of $4,000 is sold for $3,400 cash.
  3. Equipment costing $6,000 with accumulated depreciation of $500 is sold for $7,100 cash.

 

Problem Four  Fill in the blanks

a.______________________--expense recorded as the allocation of the cost of a tangible asset over its estimated useful life.

b.______________________--expense recorded as the allocation of the cost of an INTANGIBLE asset (such as a patent and copyright) over its estimated useful life.

c.______________________--expense recorded as the allocation of the cost of a natural resource (such as mineral deposit) over its extraction period.