Blueprint Problem: Fixed assets and declining method
Nature and Measurement of Fixed Assets
A noncurrent asset that is used in the normal operations of a business to generate revenue is called aFixed asset: This is also known as long-term asset; plant asset; or property, plant, and equipment. Some think that this term is inaccurate, because it could imply that the asset will last forever. For our purposes, if an asset has a useful life greater than one year, is used in the normal operations of the business, and is not intended for resale to customers, we refer to it as a fixed asset.')" >fixed asset. TheHistorical cost principle: According to the historical cost principle, fixed assets are recorded at the cost paid to acquire the asset and prepare it for its intended use and should continue to be reported at that cost until the asset is disposed of. It is also referred to as the cost concept or cost principle.')" >historical cost principleis applied to fixed assets. A fixed asset should be recorded at itsCost: The cost of a fixed asset includes any cost necessary to acquire an asset and prepare it for use. These costs are said to be capitalized, because they benefit several future periods. It is also called historical cost or original cost.')" >cost, which includes any expenditures necessary to prepare it for its intended use. The cost of a fixed asset, except for the cost ofLand: Land may be purchased to be used in the normal course of business or as an investment. Either way, it is a noncurrent asset with an indefinite life, because it is assumed to retain its usefulness. Therefore, its cost is neverallocated to expense.')" >land, is allocated as an expense. When multiple assets are purchased as a group and each asset has a different estimated life, the cost of each asset must have a separate ledger account. In the case of aGroup purchase: When two or more fixed assets are purchased as a group, the cost is allocated to each of the assets purchased, based on the proportion of the fair market value of each asset. Suppose a delivery truck and a piece of machinery are purchased for $32,000. The fair market values are $24,000 for the truck and $16,000 for the equipment, a total of $40,000. The $32,000 purchase price should be allocated as follows:
Truck: $24,000 / $40,000 = 60%
• Apply percentage to group purchase cost: $32,000 x 60% = $19,200
Machinery: $16,000 / $40,000 = 40%
• Apply percentage to group purchase cost: $32,000 x 40% = $12,800
')" >group purchase, the cost must be allocated among the assets acquired on the basis of each asset's proportion of the total fair market value of the assets acquired.
Fixed assets are reported in the Selectnoncurrent assetscurrent assetsoperating expensesCorrect 1 of Item 1 section of the Selectbalance sheetincome statementCorrect 2 of Item 1. Fixed assets with different useful lives but purchased as a group must have Selectseparate ledger accountsa group accounttheir useful lives equalizedCorrect 3 of Item 1. Land has an indefinite life and is classified as Selecta fixed assetan intangible asseta current assetCorrect 4 of Item 1.
Assume that a building and the land it is situated on, along with a dump truck, are purchased at an auction. The three assets were purchased together for a price of $320,000. The fair market value of the assets are shown in the table below. Determine each asset'sPercentage of fair market value total: Fair Market Value of Asset / Fair Market Value of Group')" >percentage of fair market value total. Then, apply that percentage to the group purchase cost to determine theAllocated cost: The group purchase cost must be allocated to each fixed asset, based on its proportion of the total fair market value of the assets purchased. The formula for each asset's allocated cost is the asset's percentage of the total fair market value times the group purchase cost.')" >allocated costto be recorded for each asset.
|
|
Fair market value
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Percent of total
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Allocated cost
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|
Land
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$115,200
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%
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$
|
|
Building
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403,200
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%
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$
|
|
Truck
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57,600
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%
|
$
|
|
Total
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$
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100%
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$320,000
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The Nature and Measurement of Depreciation
Depreciation: Fixed assets are subject to depreciation. A fixed asset's characteristics are that it (1) has a useful life greater than one year, (2) is used in the normal operations of the business, and (3) is not intended for resale to customers. The one exception is land, because it is assumed that its service potential does not decrease.')" >Depreciationis the process by which an asset's cost is allocated to expense over the asset's useful life and matched with the revenues that it helped earn. All fixed assets are depreciated with one exception-land. Depreciation is recorded with a debit toDepreciation Expense: This is the amount recorded each period that represents the portion of the asset that has expired in that period. It is an expense account and is therefore temporary and closed at the end of each period. Like all expense accounts, Depreciation Expense is reported on the income statement.')" >Depreciation Expense(an expense) and a credit toAccumulated Depreciation: This is the amount of depreciation recorded from the time when the asset was acquired. This is a contra-asset account, which is a permanent account reported on the balance sheet.')" >Accumulated Depreciation(a contra-asset). The difference between the historical cost of the asset and its accumulated depreciation is known as the asset'sBook value: Cost less accumulated depreciation equals book value. It is also referred to as carrying value or net book value. Some companies present their fixed assets at the net amount, rather than presenting historical cost and accumulated depreciation.')" >book value. The acquisition cost must be accurately measured; theUseful life: The amount of service that an asset is estimated to provide, such as hours or miles driven. Companies who plan to sell or retire assets before they are no longer productive will choose a useful life that reflects the amount of service that they expect to receive from the asset, rather than the maximum capacity of the asset, until the asset is no longer capable of providing service. (Useful life can also be measured in units of time rather than units of service.)')" >useful lifeand theSalvage value: The amount of cash or trade-in value estimated to be received at the end of the asset's useful life. It is also referred to as residual value, scrap value, disposal value, or trade-in value.')" >salvage valuemust be estimated to calculate depreciation. The difference between the cost of the asset and the salvage value is known as thedepreciable cost, the amount that will be expensed over the asset's life. By now, you should be able to complete the following statements.
1. Accumulated Depreciation is a SelectpermanenttemporaryCorrect 1 of Item 2 account.
2. Acquisition cost less salvage is Selectdepreciable costbook valueCorrect 2 of Item 2
3. At the end of an asset's useful life, book value will be equal to the Selectsalvage valueaccumulated depreciationdepreciable costCorrect 3 of Item 2
Declining Balance Depreciation
TheDeclining balance method: This method of depreciation is called an accelerated method, because depreciation expense is accelerated into the early years of an asset's life.')" onmouseout="UnTip()" class="set_of_links_href" >declining balance methodis an accelerated depreciation method. Depreciation is calculated by multiplying a constant depreciation rate by the book value. Because the book value decreases each period, so does the depreciation-hence the name, the declining balance method. The first step is to calculate the declining balance depreciation rate. The concept is that the declining-balance rate is some multiple(m): (m) represents some multiple of the straight-line rate. Many companies use the value 2, which is why this method is often called the double-declining-balance method.')" onmouseout="UnTip()" class="set_of_links_href" >(m)of theStraight-line rate: The straight-line rate is calculated by dividing 1 by the useful life in years. For example, if the useful life is four years, the straight-line rate is calculated as 1/4 = 0.25, or 25%.')" onmouseout="UnTip()" class="set_of_links_href" >straight-line rate. The formula is shown below.
Depreciation Rate = (m) x Straight-Line Rate
At the end of each period, the declining balance rate is applied to the current book value of the asset to determine the depreciation for the period. The depreciation is recorded with a debit to Depreciation Expense and a credit to Accumulated Depreciation.Note: The asset must be fully depreciated by the end of its useful life. The balance in Accumulated Depreciation should equalDepreciable cost: Cost - Salvage Value')" onmouseout="UnTip()" class="set_of_links_href" >depreciable cost, and book value should equal the residual value. Therefore, the final year's depreciation often needs to be calculated by comparing the accumulated depreciation to the depreciable cost. (See the example below.)
1. Determine the depreciation rate
2. Calculate depreciation for year 1
3. Determine the book value for year 1
4. Calculate depreciation for year 2
5. Determine the book value for year 2
6. Calculate depreciation for year 3
7. Determine the book value for year 3
8. Calculate depreciation for year 4
9. Determine the book value for year 4
10. Calculate depreciation for year 5
11. Determine the book value for year 5
12. Consider these concepts
APPLY THE CONCEPTS: Measure and record the purchase of a fixed asset
On January 1, 2011, Kulatsu Engineering acquired a new piece of machinery and a used truck from Acme Equipment Company. Kulatsu negotiated a price of $108,000 for both items. The fair market value of the equipment was $112,500, and the fair market value of the truck was $37,500. Kulatsu Engineering signed a note with Acme to make the purchase.
Prepare the journal entry to record the purchase of the equipment. Use Smart Entry when selection lists are not available to enter the account title in the Description column.
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+ Assets
+ Liabilities
+ Equity
+ Revenues/Gains
+ Expenses/Losses
How does each row of the above journal entry affect the accounting equation, and on which financial statement is it reported?