Accounting 1 Instructor Notes CHAPTER 10 FIXED ASSETS AND INTANGIBLE ASSETS McDonald's was founded in 1955 and the company now has 22,500 restaurants in 122 countries around the world. Approximately 70 percent of these restaurants are owned and operated as franchises. So how much would it cost you to open a McDonald's? It will cost you $506,000 to $1,600,100 to open a McDonald's restaurant along with a $45,000 per year franchise fee. You will be required to pay McDonald's 12.5% of all royalties along with the yearly franchise fee. Starting a McDonald's would be making a significant investment that would affect your life for years to come. In this chapter we discuss the accounting for investments in fixed assets (such as equipment for a restaurant). We also look at how to determine the portion of the fixed assets that becomes an expense over time (depreciation expense) and how to account for the disposal of a fixed assets. ACQUISITION OF PLANT ASSETS The cost of acquiring a plant asset includes all expenditures necessary to get in place and ready for use. These cost can be Capitalized, or added on to the cost of the asset (as part of the debit entry to the asset account). This can include acquiring Building, Land, or Equipment. For Equipment add the following on: sales tax transportation charges insurance on the asset while in transit special foundations installation costs
For a Secondhand Equipment, all of the above are included plus: initial costs of getting it ready new parts repairs to get it initially running painting Any other costs related to the asset (i.e. repairs from carelessness, vandalism, extended warranty costs) should not be debited to the actual asset, but should be recognized as an expense. The cost of extended warranties are also an expense (because it is for future repair work, not to get it up and running). For Building (new or used) and/or Land add on the following: fees paid to architects and engineers insurance and interest expense while being built interest incurred during construction period all other needed expenditures related to completing the project Land includes cost plus: broker's commissions title fees surveying fees delinquent real estate taxes, assumed by buyer razing or removal of any unwanted buildings on the land EXAMPLES OF CAPITALIZING OR EXPENSING Land, Land Improvement, and Building Example: When land is acquired as a building site, all costs to purchase the land and prepare it for the new building are considered a cost of land. Indicate whether the following costs should be recorded in the land (L), building (B), Land Improvement (LI) accounts, or just expensed. Following each explanation, the answers as to which account it would go to is given. $200,000 Purchase price paid for land and old warehouse building. The warehouse building will be torn down and a new manufacturing plant will be built in its place. The land has an appraised value of $125,000; the warehouse is appraised at $75,000. Answer: All $200,000 to land since we bought it with the intention of using the land for a new warehouse and will be tearing down the old warehouse. If we were just renovating the old warehouse then we would have to divide it up.
$5,000 Closing cost associated with the above purchase. Answer: Land $ 20,000 Cost to tear down and remove old warehouse. Answer: Land, you are getting land ready for the new warehouse still at this point. $8,000 Cash received from selling a crane and other salvageable materials from the old warehouse. Answer: A reduction to Land (subtract the $8,000 away from the previous numbers). $11,000 Cost to level the land prior to construction of the new building. Answer: Land, you are still getting ready for the new building. $25,000 Cost to excavate land for the foundation of the new building. Answer : Land, you are still getting ready for the new building. $60,000 Fees paid to architect to design the new building. Answer: Building $540,000 Fees paid to contractor for building the new building. Answer: Building $7,000 Interest paid on construction loan before the building is completed. Answer: Building $5,000 Repair as a result of wisdom damage during construction. Answer: Expensed $12,000 Cost of parking lot adjacent to de building. Answer: Land Improvements $ 8,000 Cost of landscaping (trees, shrubs) to beautify building and parking lot.. Answer: Land Improvements
Equipment Example: Advanced technology, a computer manufacturer, purchased a machine that applies computer chips to circuit boards, using a process known as Surface Mount Technology (SMT). The costs associated with acquiring the SMT machine are listed below. Where should each cost be recorded in the accounting records? Should it be capitalized (added on to the Equipment cost) or expensed? Purchase Price....$150,000 Transportation...1,200 Engineer s fee to set up and adjust machine to required specifications.2,000 Electrician s fee to install a new power outlet required by the SMT machine.. 800 Repairs made to wall as a result of damaged during installation of the new power outlet.....500 Cost of chips and circuits board used to test the new machine before it is used in production...300 Cost of 3 year service contract requiring the manufacturer of the SMT machine to make any repairs needed, at no cost.....3,000 ANSWER: All of the above are capitalized, or debited to the equipment account except the repair made to the wall as result of damaged during installation ( $500) and the three year service contract ($3,000). These items would be expensed because the repair was the result of damage, and the service contract is for future repairs after the machine has been running. Therefore, all other items are added and debited to equipment for a total of $ 154,300.
ACCOUNTING FOR DEPRECIATION Depreciation methods vary between assets, and within the company. Also, can use different depreciation methods for property and income tax. The three methods used most often are: Straight line Declining Balance Units of Production A. STRAIGHT LINE Cost - estimated residual value = annual depreciation estimated life The estimated residual value is the salvage that you expect to get at the end of the asset s life (trade in value when done with asset). Assume the following example: Cost of Automobile 16,000 Salvage (same as residual value) 1,000 Life 5 years 16,000-1,000 5 Depreciation equals $3,000 per year Book Value is Cost - accumulated depreciation after year 1 Book Value is-- 16,000-3,000 = 13,000
The accumulated depreciation would be just one year's worth of depreciation at the end of year one ($3000). It would look like the following on Balance sheet: Assets current: Cash $10,000 AR 7,000 Total current assets $17,000 Plant assets: Automobile $16,000 less accum. Dep. 3,000 13,000 land 20,000 Total plant assets 33,000 Total assets $50,000 ===== B. UNITS OF PRODUCTION Step 1: Get depreciation rate per hour: cost - estimated residual value = depreciation rate (usually per hour) estimated life (usually in hours) The estimated life is in something other than years. Examples would be hours, miles, etc. What if Cost is 16,000 and salvage is 1,000. Estimated hours is 10,000 hours 16,000-1,000 10,000 = $1.50 per machine hour Step 2: Get depreciation expense for year If machine was in operation for the period was 2,200 hours this year, depreciation expense would be 1.50 * 2,200 = $3,300 depreciation expense.
C. DECLINING BALANCE Most common method of estimating is to double the straight line rate. Assume the following example: Cost of Automobile 16,000 Salvage 1,000 Life 5 years 5 years = 20% depreciation per year for straight line rate Just take 1 and divide by life in years (1/5 = 20%) So double that number for 40% per year using Double declining on the balance. Salvage (residual) value is not used in the calculation of double declining (except last year). Use actual cost, not the cost less salvage. (Cost Accumulated Depreciation) * double declining rate Year 1 (no accumulated depreciation until year 2) (16,000 0) *.40 = $6400 depreciation exp. Year 1 Year 2 (16,000 6400) *.40 = $3840 Depreciation expense for year 2. Year 3 (16,000 6400-3840) *.40 = $2304 Depreciation expense for year 3. Year 4 (16,000 6400-3840 - 2304) *.40 = $1382 Depreciation expense for year 4. Year 5 (16,000 6400-3840 - 2304-1382) - 1,000 = 1,074 Depreciation expense for year 5. NOTICE in Year 5, we did NOT take times the 40%, instead we took out the 1,000 salvage (residual) value.
DISPOSAL OF PLANT ASSETS SALE OF PLANT ASSETS 1. Selling Price Below Book Assume Equipment cost is $20,000 and we have 2,000 of accumulated depreciation right now. Equipment cost Accumulated Dep. = Book Value (BV) 20,000-2,000 = 18,000 Equipment sold for 10,000. Sale price Accum. Dep = gain/loss 10,000-18,000 = 8,000 loss Cash 10,000 Acc. Dep 2,000 Loss On Disposal 8,000 Equipment 20,000 (you need to close out equipment and Accumulated dep. for the respective amounts) 2. Selling Price Above book BV is still 18,000 Sold for 21,000 21,000 18,000 = 3,000 gain Cash 21,000 Acc. Dep 2,000 Equipment 20,000 Gain on Disposal 3,000 Notice that Equipment and Accum. Dep. have to be closed out. The gain or loss is representative of how far above or below Book Value you sold the asset for.
EXCHANGING A SIMILAR FIXED ASSET The text shows how you take into consideration if there was any gain or loss between the book value of the asset given up, and the amount allowed for it on trade in. Remember you cannot value the new asset more than the retail price. INTANGIBLE ASSETS As discussed in your book, there are some items that are assets, but intangible. Examples are Patents, Copyrights, Trademarks, and Goodwill. Read about how these are handled in your text.