Accounting for Long-Term Assets - Lecture Notes | ACC 101, Study notes of Financial Accounting

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ACC101 – CHAPTER 8

Accounting for Long-Term Assets

Key Terms and Concepts to Know

Long-term assets: Cost Useful life Tangible Intangible Betterments

Depreciation/depletion/Amortization Methods: Straight-line method Units-of-production method Double-declining balance method

Disposal of Long-term assets: Discard Sale Exchange Gain/loss vs. revenue /expense

Leases: Lessor Lessee Leasehold Leasehold improvements

UNITS-OF-PRODUCTION METHOD

1. Allocates cost based on an assets usage.
2. The life of an asset is measured in units of activity, i.e. miles, or hours used.

(Cost – Residual Value) / Estimated Life in Units = Depreciation Expense Per unit

3. To calculate depreciation, multiply rate per unit times the number of units consumed.

EXAMPLE: A machine has a units-of-production rate of $2/hour.

If: 20,000 machine hours are used in year one Then: Depreciation = 20,000 * 2 = $40,

Practice Problem #

A company purchased machinery that cost $510,000. It is estimated that the machine will be operated for 100,000 hours over its useful life and have a residual value of $10,000. a. What is the rate of depreciation per hour? b. Journalize the entry for annual depreciation if the machine had been operated for 22, hours.

DECLINING BALANCE METHOD

(Cost – Accum. Depr.) * Declining Balance Rate OR Book Value * Declining Balance Rate

1. Rate = Double the rate used under the straight-line method.

a. Calculate the rate for the straight-line method

5 year useful life = 1/5 per year 1/5 = 20% Double that rate: 20% X 2 = 40%

May also be calculated as 200% / useful life

2. Use the formula to calculate the amount of depreciation. Note: Residual Value is not used in the calculation of annual depreciation until the last year. An asset may not be depreciated below its residual value.

EXAMPLE: Purchased equipment for $70,000. This equipment has a 5 year life and a $8, residual value.

a. Calculate depreciation for each of the five years using the declining balance method at twice the straight-line rate.

Straight-line rate = 1/5 or 20% Declining Rate = 40% Maximum Depreciation allowed = $62,

Annual Amt Cumulative Amt Year 1 $70,000 * 40% = $28,000 28, Year 2 (70,000 – 28,000) * 40% = $16,800 44, Year 3 (70,000 – 44,800) * 40% = $10,080 54, Year 4 (70,000 – 54,880) * 40% = $ 6,048 60, *Year 5 62,000 – 60,928 = $ 1,072 62,

*In Year 5, the asset may not be depreciated beyond its residual value. That is, the net book value may not be less than the residual value. Applying the double declining balance method in year 5 calculates an expense of (70,000 – 60,928) * 40% = $3,628.80 which reduces the book value below the residual value.

Practice Problem #

A company purchased a machine that cost $100,000. The machine is expected to last 4 years and has a residual value of $7,000. Calculate the depreciation expense to be recorded each year under the declining balance method.

DISPOSAL OF FIXED ASSETS

In All Cases

1. Accumulated depreciation and depreciation expense must be brought up to date before recording the disposal.
2. The asset and its accumulated depreciation must be removed from the accounting records.
3. Book Value = Cost – Accumulated Depreciation

2. Calculate the gain or loss. Selling Price $16, -Book Value 11,250 (50,000 – 38,750) Gain 4,

Cash 16, Accumulated Depreciation 38, Machinery 50, Gain on Disposal 4,

Practice Problem #

On July 1 a machine, which cost $75,000, was sold for $4,000. The following information was obtained from the accounting records: accumulated depreciation on December 31, $61,250; annual depreciation, $8,750. Journalize the entries to record (a) depreciation up to the date of sale and (b) the sale of the machine.

EXCHANGE OF SIMILAR ASSETS WITHOUT COMMERCIAL SUBSTANCE

1. Update depreciation to the date of trade-in.
2. Remove the old asset and its accumulated depreciation from the records.
3. Determine gain or loss by comparing the Trade-In Allowance to the Book Value. a. Gains are never recognized and not recorded; gains reduce the amount recorded for the new asset per SFAS 153. b. Losses are recognized for financial reporting, but not for tax reporting.
4. Record any cash paid.
5. Whenever a gain or loss is not recognized, the cost of the new asset acquired is adjusted. a. Decrease asset’s cost for amount of unrecognized gain. b. Increase asset’s cost for amount of unrecognized loss.

EXAMPLE #1: If a purchaser is given a $3,000 trade-in allowance on a machine with a book value of $5,000, what is the gain or loss?

Trade-In Allowance $3, Less: Book Value 5, Loss on Disposal ($2,000)

EXAMPLE #2: On January 1, equipment with a cost of $100,000 and accumulated depreciation of $92,000 is traded-in on a new machine with a cost of $150,000. The seller agrees to $140,000 cash plus the trade-in.

Trade-in Allowance $10,000 (150,000 selling price – 140,000 cash given) Book Value 8,000 (100,000 cost – 92,000 accumulated depreciation) Gain on Disposal $ 2,

The gain may not be recognized

Cost of new Asset is adjusted for the gain: Cost $150, -Gain -2, Adjusted Cost $148,

Entry: Accum. Depr.-Equipment (old) 92, Equipment (new) 148, Equipment (old) 100, Cash 140,

*Check: What is given up to obtain the new equipment? Cash $140, Old Machine 8,000 (book value) Cost of New $148,

EXAMPLE #3: On July 1 a machine with a cost of $270,000 is traded-in on a new machine with a cost of $400,000. The seller agrees to $390,000 in cash and the old machine. The following information was obtained from the accounting records; the balance of Accumulated Depreciation on January 1 was $243,000 and the annual depreciation is $27,000. Journalize the entries to (a) update depreciation and (b) record the trade-in.

Depreciation Expense 13, Accumulated Depr. 13, 27,000 * ½ year = 13,

Trade-In Allowance $10,000 (400,000 selling price – 390,000 cash) Book Value 13,500 (270,000 cost – 256,500 accum. depr.) Loss on Disposal $ 3,

The loss is recognized for financial reporting, but not for tax reporting.

SAMPLE MULTIPLE CHOICE QUESTIONS

1. Undeveloped land acquired as a speculation is listed in the balance sheet as a(n): a. Current asset b. Investment c. Plant asset d. Intangible asset
2. Accumulated Depreciation a. Is used to show the amount of cost expiration of intangibles b. Is the same as Depreciation Expense c. Is used to show the amount of cost expiration of natural resources d. Is a contra asset
3. A machine with a cost of $130,000 has an estimated residual value of $10,000 and an estimated life of 4 years or 18,000 hours. What is the amount of depreciation for the second full year, using the declining-balance method at double the straight-line rate? a. $30, b. $31, c. $32, d. $65,
4. A machine with a cost of $130,000 has an estimated residual value of $10,000 and an estimated life of 4 years or 16,000 hours. Using the units-of-production method, what is the amount of deprecation for the second full year, during which the machine was used 4,000 hours? a. $26, b. $24, c. $30, d. $32,
5. Equipment with a cost of $80,000 has an estimated residual value of $5,000 and an estimated life of 4 years or 12,000 hours. It is to be depreciated by the straight-line method. What is the amount of depreciation for the first full year, during which the equipment was used 3,300 hours? a. $20, b. $18, c. $20, d. $22,

6. The depreciation method that does not use residual value in calculating the first year’s depreciation expense is: a. Straight-line b. Declining balance c. Units-of-production d. None of the above
7. Expenditures that add to the utility of plant assets for more than one accounting period are: a. Capital expenditures b. Revenue expenditures c. Current expenditures d. Additional expenditures
8. A plant asset with a cost of $60,000 is traded for a similar asset priced at $80,000. Assuming accumulated depreciation of $55,000 and a trade-in allowance of $6,000, what is the cost basis of the new asset for financial reporting purposes? a. $75, b. $79, c. $86, d. $80,
9. A plant asset with a cost of $15,000 is traded for a similar asset priced at $20,000. Assuming accumulated depreciation of $12,500 and a trade-in allowance of $1,500, what is the cost basis of the new asset for financial reporting purposes? a. $20, b. $15, c. $21, d. $12,
10. All leases are classified as either: a. Capital Leases or Operating Leases b. Capital Leases or Long-Term Leases c. Operating Leases or Current Leases d. Long-Term Leases or Current Leases
11. Which on of the following is NOT an internal control procedure for plant assets? a. Ensuring that plant assets are acquired at the lowest possible costs b. Training employees to properly operate plant assets c. Recording assets in the subsidiary ledger only at year end d. Tagging assets as they are acquired

17. An asset purchased on January 1 for $48,000 has an estimated salvage value of $3,000. The current year’s Depreciation Expense is $5,000 and the balance of the Accumulated Depreciation account, after adjustment, is $20,000. If the company uses the straight-line method, what is the asset’s remaining useful life? a. 9 years b. 4 years c. 8 years d. 5 years
18. Book value is the same as market value. a. True b. False
19. Coronado Company purchased land for $80,000. The company also paid $12,000 in accrued taxes on the property, incurred $5,000 to remove an old building, and received $2,000 from the salvage of the old building. The land will be recorded at: a. $80, b. $95, c. $92, d. $83,
20. On April 1, 2001 La Presa Company sells some equipment for $18,000. The original cost was $50,000, the estimated salvage value was $8,000, and the expected useful life was 6 years. On December 31, 2000 the Accumulated Depreciation account had a balance of $29,400. The gain or loss on the sale was: a. $2,600 gain b. $300 gain c. $850 loss d. $5,400 gain
21. On January 1, 2000 Jamacha Company purchased some equipment for $15,000. The estimated salvage value and useful life are $3,000 and 4 years, respectively. On January1, 2002, the company determines that the asset’s remaining useful life is 3 years. What is the revised depreciation expense for 2002 if the company uses the straight-line method? a. $3, b. $2, c. $4, d. $2.

22. On March 1, 2002, Moreno Company purchased a patent from another company for $90,000. The estimated useful life of the patent is 10 years, and its remaining legal life is 15 years. The Amortization Expense for 2002 is: a. $9, b. $7, c. $6, d. $5,
23. On September 1, 2001, Dulzura Company purchased an asset for $9,000, with a $1, estimated salvage value, and a 4-year useful life. The 2001 depreciation expense using the straight-line method would be: a. $ b. $ c. $1, d. $2,
24. Otay Company purchased land for $70,000 on 12/31/01. As of 5/30/02, the land increased in value to $71,500. On 12/31/02, the land was appraised for $74,000. The Land account should be increased by: a. $4, b. $1, c. $2, d. $
25. Revenue expenditures are expensed as incurred. a. True b. False
26. Which of the following costs would not be included in the cost of the equipment? a. Insurance b. Installation c. Testing d. Freight
27. Which of the following is not a depreciable asset? a. Land improvements b. Equipment c. Buildings d. Land

1. Trade-In Allowance $84,000 (450,000 – 366,000)

(20,000 * ½ year = 10,000)

Trade-In Allowance $40,000 (250,000 – 210,000)

• Practice Problem #
  • Depreciation Expense 4, - Accumulated Depreciation 4, - 8,750 * ½ year = $4, - Accumulated Depreciation: 61,250 + 4,375 = $65,
  • Cash 4,
  • Loss on Disposal 5,
  • Accumulated Depreciation 65, - Equipment 75, - Book Value: 75,000 – 65,625 = 9, - Loss: 4,000 – 9,375 = $5,
• Practice Problem #
  • Gain $ 4, Book Value 80,000 (400,000 – 320,000)
  • Cost of New Equipment $450, Gain may not be recognized; therefore the cost basis of the new equipment will be adjusted.
  • Less: Gain 4,
  • Adjusted Cost of New $446,
  • Equipment (new) 446,
  • Accumulated Depr. 320, - Equipment (old) 400, - Cash 366,
• 2. Depreciation Expense 10,
     • Accumulated Depreciation 10,
  • Loss $10, Book Value 50,000 (180,000 – 130,000)

For financial reporting the loss may be recognized.

Equipment (new) 250, Accumulated Depreciation 130, Loss of Disposal 10, Equipment (old) 180, Cash 210,

SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1. B

2. D

3. C: 4-year life = 25% per year under straight-line * 2 = 50% declining rate Year 1: 130,000 * 50% = 65, Year 2: 65,000 * 50% = 32,
4. C: (130,000 – 10,000) / 16,000 hours = $7.50 per hour 4,000 hours * 7.50 per hour = $30,
5. B: (80,000 – 5,000) / 4 = $18,
6. B
7. A
8. B 60,000 cost – 55,000 accumulated depreciation = 5,000 book value 6,000 trade-in - 5,000 book value = 1,000 gain Reduce cost by gain: 80,000 – 1,000 = 79,
9. A 15,000 cost – 12,500 accumulated depreciation = 2,500 book value 1,500 trade-in – 2,500 book value = 1,000 loss Do not adjust cost basis
10. A
11. C
12. D
13. B
14. A The higher the ratio the less debt in comparison with fixed assets
15. A Do not include patents and deduct accumulated depreciation
16. A 18,000 cost + 500 freight + 2,500 installation = $21, 21,000 cost – 2,000 salvage = $19,000 / 4 years = $4,
17. D Annual Depreciation: (48,000 – 3,000) / useful life in years = 5, Useful life = 9 Number of years passed: 20,000 accumulated depreciation / 5,000 annual depreciation = 4 years 9-year useful life - 4 years passed = 5 years left