192 Chapter 10 Fixed Assets and Intangible Assets
OBJECTIVE 3
Journalize entries for the disposal of fixed assets.
SYNOPSIS
After a fixed asset is no longer used by a business, it is either discarded or sold. If the asset has no
residual value and is discarded, this event must be recorded on the books of the business. The asset is
removed from assets by debiting the associated accumulated depreciation account and crediting the asset
account for the full cost of the asset. If the asset is not fully depreciated, the depreciation should be
recorded up to the date of removal. The discarding is then recorded as a credit to Accumulated
Depreciation, a debit to Loss on Disposal (for the undepreciated amount), and a credit for the full value of
the asset. If the asset still has value, it may be sold. The sale price should be compared to the book value
prior to the recording of the transaction to determine if there is a loss or a gain on the sale. If the asset is
sold for an amount equal to the book value, the transaction is recorded as a debit to Cash and
Accumulated Depreciation and a credit for the full cost of the asset. If the asset is sold for less than the
book value, Cash, Accumulated Depreciation, and Loss on Sale are debited, and the asset account is
credited for the full cost of the asset. If the asset is sold for more than the book value of the asset, Cash
and Accumulated Depreciation are debited, the asset account is credited for the full cost of the asset, and a
credit is recorded for gain on the sale of the asset for the difference between cash, accumulated
depreciation, and the cost of the asset. All three of the preceding transactions are shown on page 474.
Relevant Example Exercises and Exhibits
• Example Exercise 10-6 Sale of Equipment
SUGGESTED APPROACH
Whenever a business disposes of a fixed asset—however a business disposes of a fixed asset—both the
asset and its accumulated depreciation must be removed from the accounting records. Remind students
that depreciation must be brought up to date before recording the disposal of an asset. Use the following
notes and Demonstration Problems to illustrate the discard, sale, and exchange of fixed assets.
LECTURE AID—Discarding Fixed Assets
To record a discarded fixed asset:
1. Remove the asset and its accumulated depreciation from the accounting records.
2. If the asset is not fully depreciated, record a loss equal to the book value of the asset.
Ask your students to record in their notes the discard of the following two assets. After a few minutes,
review the correct answers.
Chapter 10 Fixed Assets and Intangible Assets 193
Machine #1: Original cost, $10,000; accumulated depreciation, $10,000
Entry: Accumulated Depreciation—Machinery 10,000
Machinery…………………….. 10,000
Machine #2: Original cost, $25,000; accumulated depreciation, $20,000
Entry: Accumulated Depreciation—Machinery 20,000
Loss on Disposal of Fixed Assets…….. 5,000
Machinery…………………….. 25,000
LECTURE AID—Selling Fixed Assets
To record the sale of a fixed asset:
1. Remove the asset and its accumulated depreciation from the accounting records.
2. Record the cash received.
3. Record any gain or loss. The gain or loss can be determined by comparing the book value of the asset
to the cash received.
Ask students to record the sale of the following two assets. Then review the correct answers.
Machine #1: Original cost, $50,000; accumulated depreciation, $35,000; sold for $18,000
Entry: Cash……………………………………. 18,000
Accumulated Depreciation—Machinery 35,000
Machinery……………………… 50,000
Gain on Disposal of Fixed Assets 3,000
Machine #2: Original cost, $75,000; accumulated depreciation, $65,000; sold for $4,000
Entry: Cash……………………………………. 4,000
Accumulated Depreciation—Machinery 65,000
Loss on Disposal of Fixed Assets…….. 6,000
Machinery…………………….. 75,000
Note: Discussion concerning exchanging a fixed asset for similar fixed asset appears in the appendix to
the chapter. This material could be discussed here if the instructor chooses to include the appendix
material as part of the chapter discussion.
194 Chapter 10 Fixed Assets and Intangible Assets
OBJECTIVE 4
Compute depletion and journalize the entry for depletion.
SYNOPSIS
The fixed assets of some companies include natural assets such as timber, minerals, etc. These resources
are harvested and then sold. A portion of the cost of the asset is recorded as an expense. This process of
transferring the cost of the asset to an expense account is called depletion. Depletion expense is
determined by first calculating the depletion rate: depletion rate = cost of resource/estimated total units of
resource. The second step is completed by multiplying the depletion rate by the quantity of the resource
extracted: depletion expense = depletion rate × quantity extracted. This is recorded as an adjusting entry
at the end of the period. The entry is a debit to Depletion Expense and a credit to Accumulated Depletion.
Similar to depreciation, Accumulated Depletion is a contra asset account.
Key Terms and Definitions
• Depletion – The process of transferring the cost of natural resources to an expense account.
Relevant Example Exercises and Exhibits
• Example Exercise 10-7 Depletion
SUGGESTED APPROACH
Mining companies purchase rights to mineral deposits or natural resources like timber. These rights are
recorded in an asset account when they are purchased. As the metal ore or minerals are mined, they must
be removed from the asset account and shown as an expense. This process is called depletion. It works
like the contra asset account Accumulated Depreciation to reduce the overall value of the associated asset
while keeping the original cost of the asset on the books. Depletion is always computed using a units-of-
production method. Use the Demonstration Problem to show how depletion is calculated and journalized.
Depletion rate = cost of resources/estimated total units of resources
DEMONSTRATION PROBLEM—Depletion
A company purchased the rights to a mineral deposit for $500,000. Engineers estimate that the deposit
contains 2 million tons of ore. During the first year of mining operations, 450,000 tons of ore were
removed. What depletion expense would be recorded that first year?
$500,000/2 million tons = $0.25/ton
450,000 tons $0.25/ton = $112,500
Journal Entry: Depletion Expense…………… 112,500
Accumulated Depletion…… 112,500
Chapter 10 Fixed Assets and Intangible Assets 195
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OBJECTIVE 5
Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.
SYNOPSIS
Businesses may also own long-term assets that are intangible. They are called intangible because they do
not exist physically. They include patents, copyrights, trademarks, and goodwill. Accounting for these
assets is similar to that of fixed assets. To account for this asset, the business first determines its initial
cost. Amortization is the decline in the usefulness of an intangible asset. After a business determines the
cost of the asset, the amortization expense is determined by dividing the cost by the estimated number of
years of its useful life. This is recorded by debiting Amortization Expense and crediting the asset. If a
company develops its own patents through research and developments, the cost has already been
accounted for through research and development expenses and cannot be recorded twice. Intangible assets
are given varying legal time limits by the federal courts. Copyrights are issued for 70 years beyond the
life of the author. Trademarks can be registered for a 10-year time period, when it can then be renewed. If
a trademark is impaired, it can be written down. Goodwill refers to an intangible that is created from
favorable factors like location, product quality, reputation, etc. It cannot be amortized; however, a loss
can be recorded if the future prospects of the business are impaired.
Key Terms and Definitions
• Amortization – The periodic transfer of the cost of an intangible asset to expense.
• Copyright – An exclusive right to publish and sell a literary, artistic, or musical composition.
• Goodwill – An intangible asset that is created from such favorable factors as location, product
quality, reputation, and managerial skill.
• Intangible Assets – Long-term assets that are useful in the operations of a business, are not held
for sale, and are without physical qualities.
• Patents – Exclusive rights to produce and sell goods with one or more unique features.
• Trademark – A name, term, or symbol used to identify a business and its products.
Relevant Example Exercises and Exhibits
• Example Exercise 10-8 Impaired Goodwill and Amortization of Patent
• Exhibit 11 – Frequency of Intangible Asset Disclosure for 500 Firms
• Exhibit 12 – Comparison of Intangible Assets
SUGGESTED APPROACH
Intangible assets are long-term assets that have no physical substance but benefit operations. Emphasize
that in most cases, intangible assets involve legal rights. For example, a copyright is the legal right to
publish and sell printed material.
Begin your coverage by reviewing the major categories of intangibles (patents, copyrights and
trademarks, goodwill) using TM 10-14. TM 10-15 summarizes the ongoing accounting treatment for
intangibles. Emphasize the value of intangibles through the real-world case example that follows.
196 Chapter 10 Fixed Assets and Intangible Assets
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Patents and goodwill are two intangibles that merit additional coverage of methods for determining cost.
Use the Lecture Aid below to explain the differences in costs capitalized for a purchased and an internally
developed patent, due to accounting rules regarding the treatment of research and development expenses.
A Lecture Aid is also provided to explain the nature of goodwill. To sum up your coverage of fixed
assets, natural resources, and intangible assets, review TM 10-16 with your students.
In addition, emphasize the differences in expensing the intangible assets. Patents, copyrights, etc., are
amortized over a period of time. However, trademarks and goodwill are expensed as impairment losses.
LECTURE AID—Patents
If a patent is purchased, the full purchase price is recorded in the Patent account. In most cases, the
purchase price of the patent would reimburse the seller for research costs in developing the product
patented, as well as for the legal costs of filing and defending the patent.
If a patent is developed internally, only the legal costs to file and defend the patent may be recorded in the
Patent account. All research and development costs to discover and perfect the product or technology
must be recorded as expenses as they are incurred. Research and development costs are expensed because
a company can never be sure whether or not its projects will lead to marketable products. Once a product
is determined to be marketable, it would be difficult to go back and trace all the costs that went into the
product—especially since it may have taken several years to develop the product.
As a result, patents that are developed internally will be carried at a substantially lower value than patents
that are purchased.
LECTURE AID—Goodwill
Let’s say that you wanted to open a restaurant that specializes in pizza. You price ovens, refrigerators,
tables, chairs, cash registers—all the items you need to open your restaurant. You discover that the
needed equipment will cost $75,000. You also hear that the owner of a local pizzeria wants to sell his
business. This business has all of the equipment you had priced for your own store. Although this
equipment is used, it is in good working order. The business is in a location equivalent to the one you
were considering. This pizzeria has been in business for more than 20 years and has an established
clientele. The owner is asking $125,000 for his business. How can the owner of the established pizzeria
justify asking $125,000 for a business, when the same equipment could be purchased new for $75,000?
Whenever a company is purchased at a price higher than the value of its assets, goodwill is recognized. If
you were to purchase the established pizzeria, you would record the following entry:
Assets (list actual accounts) 75,000
Goodwill…………………. 50,000
Cash……………… 125,000
Remind the students that goodwill is not amortized.
Chapter 10 Fixed Assets and Intangible Assets 197
OBJECTIVE 6
Describe how depreciation expense is reported in an income statement and prepare a
balance sheet that includes fixed assets and intangible assets.
SYNOPSIS
Financial statements often record depreciation, depletion, and amortization separately because they
increase expenses and reduce revenues but require no cash outlay. The income statement usually reports
these expenses separately, and a description of the methods used to determine the expenses is disclosed.
On the balance sheet, each class of assets is reported separately along with the accumulated depreciation.
Alternatively, the fixed assets may be shown at their book value. Supporting notes also disclose how
much of depreciation, depletion, or amortization has been accumulated.
SUGGESTED APPROACH
Review the following information regarding income statement and balance sheet disclosures:
Income Statement—must show amount of depreciation and amortization expense, either on the statement
or in a footnote. It also must disclose the method used to calculate depreciation.
Balance Sheet—must show the balance of each major class of fixed assets, along with the accumulated
depreciation (either by class or in total). Mineral rights and ore deposits (less accumulated depletion) are
shown as part of the fixed asset section. Other intangible assets are listed in their own section, net of
amortization taken to date, immediately following the fixed assets.
GROUP LEARNING ACTIVITY—Income Statement and Balance Sheet
Using TM 10-17, ask your students to prepare the assets section of a balance sheet for Georgia
Electronics Co. The solution is presented in TM 10-18.
OBJECTIVE 7
Describe and illustrate the fixed asset turnover ratio to assess the efficiency of a company’s
use of its fixed assets.
SYNOPSIS
The financial ratio demonstrated is the fixed asset turnover ratio, which measures a company’s efficiency
in using its fixed assets to generate revenue. It is computed as: fixed asset turnover ratio = sales/average
book value of fixed assets. The higher this ratio is, the more efficiently the company is using its fixed
assets. Smaller ratios are usually associated with businesses that require large asset investments, and
higher ratios are associated with firms that require smaller fixed assets or are more labor intensive.
198 Chapter 10 Fixed Assets and Intangible Assets
Key Terms and Definitions
• Fixed Asset Turnover Ratio – The number of dollars of sales that are generated from each dollar
of average fixed assets during the year, computed by dividing the sales by the average net fixed
assets.
Relevant Example Exercises and Exhibits
• Example Exercise 10-9 Fixed Asset Turnover Ratio
• Exhibit 13 – Fixed Asset Turnover Ratio Examples
SUGGESTED APPROACH
After reviewing the computation of this ratio, use TM 10-19 to begin a discussion of which factors could
cause a company’s ratio from year to year to change or remain the same.
Possible explanation: The higher the ratio, the more efficiently a company is using fixed assets. The ratio
is affected two possible ways: 1) fluctuation in net income and 2) changes to average book value of fixed
assets. If fixed assets remain relatively unchanged, increases to net income will affect the ratio positively
and decreases will affect it negatively. Changes in book value can take place through the natural
depreciation process. If a company is not investing in new fixed assets, the average book value will
decrease as fixed assets are depreciated and the ratio will improve if net income remains constant.
Companies investing in fixed assets could show a decline in the ratio as the average book value will
increase based on this new investment.
Also, remind students that smaller ratios are associated with companies that require large fixed asset
investments, such as restaurants or airlines, while larger ratios are associated with companies that are
more labor-intensive, thus requiring smaller fixed asset investments, such as firms in the service industry.
APPENDIX—EXCHANGING SIMILAR FIXED
ASSETS
SYNOPSIS
Sometimes businesses do not purchase assets with cash but exchange assets with other companies or trade
in old equipment for new equipment. Accounting for these transactions depends on whether the future
cash flows of the business will change as a result of the exchange. If the exchange lacks commercial
substance, no gain or loss is recognized. If the exchange has commercial substance, a gain or loss is
recorded. The gain or loss is determined by comparing the book value of the asset given up to the fair
market value or trade-in allowance. If the exchange is unequal in value and cash is also paid, it is called
boot. The transactions shown on pages 482 and 483 demonstrate these types of exchanges.
Chapter 10 Fixed Assets and Intangible Assets 199
Key Terms and Definitions
• Boot – The amount a buyer owes a seller when a fixed asset is traded in on a similar asset.
• Trade-In Allowance – The amount a seller allows a buyer for a fixed asset that is traded in for a
similar asset.
SUGGESTED APPROACH
Please note that in presenting the journal entries for the exchange of similar assets, the value placed on the
new assets received in a gain situation is called a “plug” number. If that overly simplistic approach is
offensive, the text presents two methods for calculating the amount to be capitalized on pages 482–483.
LECTURE AID—Exchanging Similar Fixed Assets
To record the exchange of a fixed asset for a similar fixed asset:
1. Remove the old asset and its accumulated depreciation from the accounting records.
2. Record any cash paid.
3. If there is a loss or gain on the exchange, it can be recorded for financial reporting purposes.
Most exchanges of fixed assets are trade-in arrangements, where an old asset plus some cash are
exchanged for a new asset. To determine whether there is a gain or a loss on the trade, you must compare
the book value of the old asset to the trade-in allowance granted toward a new asset. For example, if a
purchaser is given a $3,000 trade-in allowance on a machine with a book value of $5,000, the purchaser
would have a $2,000 loss.
DEMONSTRATION PROBLEM—Exchanging Similar Fixed Assets
A piece of equipment with an original 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 has agreed to take $140,000 cash plus the
old equipment in exchange for the new machine. Record this transaction.
Cost of new machine $150,000
Cash (boot) paid 140,000
Trade-in allowance $ 10,000
Book value of old machine $ 8,000
Trade-in allowance 10,000
Gain $ 2,000
Entry: Accumulated Depreciation—Equipment (old) 92,000
Equipment (new) 150,000
Equipment (old)…………….. 100,000
Cash………………………… 140,000
Gain on Exchange of Assets… 2,000
200 Chapter 10 Fixed Assets and Intangible Assets
A second piece of equipment with an original cost of $270,000 and accumulated depreciation of $250,000
is traded in on a new machine with a cost of $400,000. The seller has agreed to take $385,000 cash plus
the old equipment in exchange for the new machine. Record the following transaction:
Cost of new machine $400,000
Cash (boot) paid 385,000
Trade-in allowance $ 15,000
Book value of old machine $ 20,000
Trade-in allowance 15,000
Loss $ 5,000
Entry: Accumulated Depreciation—Equipment (old) 250,000
Equipment (new)…………………………….. 400,000
Loss on Disposal of Fixed Assets……………. 5,000
Equipment (old)……………………… 270,000
Cash………………………………….. 385,000
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP – APC Bloom‘s EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 2 1 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 3 1 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 4 1 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 5 1 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 6 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 7 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 8 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 9 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
DQ 10 5 Easy 5 min. Analytic Measurement Long-term Asset Reporting Remembering
PE 6B Sale of equipment 3 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
PE 7A Depletion 4 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
PE 7B Depletion 4 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
PE 8A Impaired goodwill and amortization of patent 5 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 9 Straight-line depreciation 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 10 Depreciation by units-of-production method 2 Easy 5 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 11 Depreciation by units-of-production method 2 Moderate 10 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 12 Depreciation by two methods 2 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 24 Sum-of-the-years-digits depreciation 7 Easy 10 min. Analytic Measurement Long-term Asset Reporting Applying x
EX 25 Asset traded for similar asset Appendix Moderate 10 min. Analytic Measurement Long-term Asset Reporting Applying
EX 26 Asset traded for similar asset Appendix Moderate 10 min. Analytic Measurement Long-term Asset Reporting Applying
EX 27 Entries for trade of fixed asset Appendix Moderate 10 min. Analytic Measurement Long-term Asset Reporting Applying
CP 4 Applying for patents, copyrights and trademarks 5 Moderate 1 hour Reflective Thinking Critical Thinking Long-term Asset Reporting Remembering
CP 5 Fixed asset turnover; three industries 7 Moderate 15 min. Analytic Measurement Long-term Asset Reporting Analyzing x
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