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167
chapter
9
Fixed Assets and
Intangible Assets
______________________________________________
OPENING COMMENTS
Chapter 9 addresses fixed assets, intangible assets, natural resources, and the accounting issues related to
these assets.
After studying the chapter, your students should be able to:
2. Compute depreciation, using the following methods: straight-line method, units-of-production
method, and double-declining-balance method.
4. Compute depletion and journalize the entry for depletion.
6. Describe how depreciation expense is reported in an income statement and prepare a balance sheet
that includes fixed assets and intangible assets.
7. Describe and illustrate the fixed asset turnover ratio to assess the efficiency of a company’s use of its
fixed assets.
KEY TERMS
accelerated depreciation method
amortization
book value
boot
capital expenditures
168 Chapter 9 Fixed Assets and Intangible Assets
capital lease
copyright
depletion
depreciation
double-declining-balance method
fixed asset turnover ratio
STUDENT FAQS
• Why is three to six months a reasonable time to get an asset such as used delivery truck up and
running?
• When an extraordinary repair is made to an asset, why do you debit accumulated depreciation?
Wouldn’t it be easier to simply debit the asset account? After all, the value to the asset has just
increased due to the repair.
• When you have a gain on the exchange of similar assets, why don’t you show it?
• Which method of depreciation is always best to use?
• Why do accountants have to classify items as capital or revenue expenditures?
• Is it true that the higher the depreciation, the lower the net income? If that is the case, why would we
not want the lowest depreciation method so we can show the highest net income?
Chapter 9 Fixed Assets and Intangible Assets 169
• How can you depreciate an asset that is going up in value? There is no cost to using it, since it can be
sold for more than cost when you are through with it.
• Why is interest during construction part of the cost of a building and not an expense?
• In order to buy a car, I must have insurance and buy license plates. Is this part of the cost of the car?
OBJECTIVE 1
Define, classify, and account for the cost of fixed assets.
SYNOPSIS
A fixed asset has the following characteristics: it is tangible, owned by the business, used in normal
operations, and not offered for sale in the normal course of business. A cost may be classified as a fixed
asset, an investment, or an expense. Exhibit 2 shows how to classify cost to determine how it should be
recorded. Assets recorded as fixed assets include land, buildings, and equipment. These assets last more
than one year. Investments are long-term assets that are not used in the normal course of business.
Key Terms and Definitions
• Capital Expenditures - The costs of acquiring fixed assets, adding to a fixed asset, improving a
fixed asset, or extending a fixed asset’s useful life.
• Capital Lease - A lease that includes one or more provisions that result in treating the leased
assets as purchased assets in the accounts.
• Fixed Assets (or Plant Assets) - Long-term or relatively permanent tangible assets such as
equipment, machinery, and buildings that are used in the normal business operations and that
depreciate over time.
• Operating Lease - A lease that does not meet the criteria for capital leases and thus is accounted
for as an operating expense.
170 Chapter 9 Fixed Assets and Intangible Assets
Relevant Examples Exercises and Exhibits
• Example Exercise 9-1 Capital and Revenue Expenditures
• Exhibit 1 – Fixed Assets as a Percent of Total Assets—Selected Companies
SUGGESTED APPROACH
Review the definition of fixed assets. Ask students to give examples of fixed assets, listing them on the
board as they are called out.
LECTURE AID—Defining Fixed Assets
Fixed assets are long-term (or relatively permanent) assets that can be used in a business. Emphasize that
the word “used” is essential in this definition. As long as the asset is capable of being used, it is
considered a fixed asset. Therefore, equipment held as back-up in case regular equipment breaks or there
is abnormally high volume is a fixed asset. If an asset is being held for sale or future use, but it is not
capable of being used in its current condition (such as undeveloped land), it should be classified as an
investment, not a fixed asset.
The costs of acquiring fixed assets can be summarized by the following general rule:
GENERAL RULE: The cost of acquiring a fixed asset includes all costs necessary to get the asset to its
place of use and ready for use.
related to a building.
LECTURE AID—Nature of Depreciation
The nature of depreciation was explained in Chapter 3. However, a considerable amount of material has
been covered since that explanation. You will probably want to explain the nature of depreciation again to
ensure that the class is focused on the correct concept before beginning depreciation calculations. In this
review, emphasize once again that accounting is concerned only with allocating the cost of an asset to the
period in which it is used. Accountants do not attempt to track the market value of an asset.
Chapter 9 Fixed Assets and Intangible Assets 171
they are learning how to determine the decrease in market value of an asset.)
Use the following story (TM 9-5) to reinforce the concept of depreciation, which was introduced in
Chapter 3:
Assume you have just accepted a job that requires you to do a lot of driving. Because your current car is
on its “last leg,” you have decided to purchase an automobile. You estimate that you will drive 20,000
miles each year. Since you don’t like to deal with major car repairs, you will trade in the car when it
reaches 60,000 miles. You have found two cars that you are considering. One is a new car, and you can
purchase it for $18,000. The other is a late-model used car. The used car has 20,000 miles on it, but it is in
excellent condition. The price of this used car is $11,000.
Using the criteria outlined, what would be your depreciation cost per year for each car?
Answer: New Car: $18,000/3 = $6,000
Used Car: $11,000/2 = $5,500
172 Chapter 9 Fixed Assets and Intangible Assets
REMINDER: The adjusting entry to reduce supplies credits the supplies account, reducing it directly for
the amount of supplies that are physically gone. Since depreciation is only an estimate of the usefulness of
a long-term asset that has expired, the Asset account is not reduced directly. Rather, a contra-account
called Accumulated Depreciation is used to reduce the asset.
For example, the adjusting entry to record depreciation on a piece of machinery would be:
INTERNET ACTIVITY—Fixed Assets
Instruct your students to search the Web using “fixed assets” as their search criteria. This search will
bring up many Web sites promoting fixed asset software packages. Ask your students to pick a software
package and describe its capabilities. Sage Software has several fixed asset packages. Information can be
found at http://www.sagesoftware.com/.
LECTURE AID—Capital and Revenue Expenditures
Review the definitions of capital and revenue expenditures and their accounting treatment by using TMs
9-10 and 9-11. Next, give your students an opportunity to apply these definitions in practice through a
Group Learning Activity.
GROUP LEARNING ACTIVITY—Capital and Revenue Expenditures
TM 9-11 lists several expenditures related to fixed assets. Ask your students to classify each as a capital
or a revenue expenditure. Also instruct them to name the specific account that would be debited to record
each expenditure. TM 9-12 presents the solution.
Chapter 9 Fixed Assets and Intangible Assets 173
LECTURE AID—Capital Leases
Use the following scenario (TM 9-13) to introduce capital leases:
Company A: Purchases a $250,000 asset that has an estimated 15-year life, after which time it will have a
$10,000 salvage value. The asset is purchased on credit. Therefore, Company A records a $250,000 asset
and a $250,000 liability.
Company B: Leases the same $250,000 asset for 15 years. At the end of the 15 years, the company has
the right to purchase the asset for $100. Since Company B does not own the asset, it does not record the
asset on its accounting records. In addition, it does not recognize any liability related to the lease.
Is this a fair accounting treatment?
In 1976, the Financial Accounting Standards Board decided that it was unacceptable for Company B to
avoid recording a $250,000 debt on its balance sheet just because it used something legally called a
“lease” to obtain use of the asset.
The criteria to determine if a lease is a capital lease are not presented in the text; this is more an
intermediate accounting concern. However, in case your students ask, a lease is classified as a capital
lease if it meets one of these four criteria:
2. The lease contains an option for a bargain purchase of the asset by the lessee.
4. The lease requires rental payments that compensate the leaser for 90 percent or more of the fair
market value of the asset.
If the lease does not meet any of these criteria, it is classified as an operating lease. Under an operating
lease, the lessee records lease payments as rent expense. The asset and the lease obligation are not
recorded in the accounting records.
174 Chapter 9 Fixed Assets and Intangible Assets
OBJECTIVE 2
Compute depreciation, using the following methods: straight-line method, units-of-
production method, and double-declining-balance method.
SYNOPSIS
Depreciation can be caused by physical or functional factors. Depreciation is an allocation of a fixed
asset’s cost to expense over the asset’s useful life. Depreciation does not provide cash to replace the asset.
The three factors that determine depreciation expense are the asset’s initial cost, the expected useful life,
and the estimated residual value. Straight-line, units-of-output, and double-declining-balance methods
will be discussed in this objective. Some companies may use all three methods for different assets.
Any of the three methods of depreciation discussed above may be used for financial purposes. However,
when filing taxes, the IRS mandates a method of depreciation called MACRS. This method classifies
each asset in a class, commonly a five- or seven-year class. When determining the depreciation expense,
the residual value is ignored and the cost of the asset is multiplied by a different predetermined
percentage each year resulting in the expense for that year. Exhibit 9 shows the informational chart used
to determine the depreciation for a five-year asset. If during the life of an asset, it is determined that the
useful life has changed, only future depreciation expense is changed. Depreciation expense recorded in
past years is not affected.
Key Terms and Definitions
• Accelerated Depreciation Method - A depreciation method that provides for a higher
depreciation amount in the first year of the asset’s use, followed by a gradually declining amount
of depreciation.
Chapter 9 Fixed Assets and Intangible Assets 175
Relevant Example Exercises and Exhibits
• Example Exercise 9-2 Straight-Line Depreciation
• Example Exercise 9-3 Units-of-Output Depreciation
SUGGESTED APPROACH
The three factors used in determining depreciation are a fixed asset’s (1) initial cost, (2) useful life, and
(3) residual value. Review the formulas for each depreciation method, and give your students an
opportunity to apply these formulas using a Group Learning Activity.
LECTURE AID—Straight-Line and Units-of-Production Methods
The straight-line depreciation method allocates the cost of an asset evenly over the number of years it is
used. The formula to calculate the depreciation expense recorded each year is as follows:
(Cost – Residual Value)/Number of Years of Useful Life
Remind students that under the straight-line method, the depreciation expense recognized is the same
each year. Point out that assets purchased mid-year receive a partial year’s depreciation. Calculate the
depreciation for the entire year and then multiply the entire year’s depreciation by the percent of the year
the asset is used. For example, an asset purchased on April 1 would be used for 9 months. Prorate its
depreciation by multiplying by 9/12.
176 Chapter 9 Fixed Assets and Intangible Assets
GROUP LEARNING ACTIVITY—Straight-Line and Units-of-Production
Depreciation
TM 9-6 presents a depreciation exercise for small groups. The solution is provided on TM 9-7.
LECTURE AID—Double-Declining-Balance Method
The formula for double-declining-balance depreciation is as follows:
1. Calculate the rate that would be used under straight-line depreciation.
Example: A $10,000 machine will be used for five years. At that time, the machine’s salvage value
2. Double the straight-line rate to get the declining-balance rate.
Declining-balance rate = 20% 2 = 40%
3. Use the formula to calculate declining-balance depreciation.
(Cost – Accumulated Depreciation) Declining-Balance Rate
Chapter 9 Fixed Assets and Intangible Assets 177
GROUP LEARNING ACTIVITY—Declining-Balance Depreciation
Using TM 9-8, ask your students to calculate depreciation under the declining-balance method.
LECTURE AID—Comparing Depreciation Methods
Point out that the declining-balance method is called an accelerated depreciation method since the
depreciation expense is highest in the first year of the asset’s life and gradually declines.
The benefits of accelerated depreciation are:
2. Higher depreciation charges drive net income down in the early years of an asset’s life. As a result,
accelerated depreciation methods are favored for tax purposes.
LECTURE AID—Tax Depreciation
Stress that assets are depreciated for tax purposes using methods prescribed by the Internal Revenue
Service (IRS). Therefore, a company may be recording different depreciation for tax and financial
accounting purposes. Assets acquired after 1986 are depreciated using the Modified Accelerated Cost
LECTURE AID—Miscellaneous
In addition to the information above, you may want to stress the following points.
1. Revision of Depreciation—If estimates of a fixed asset’s residual value or useful life change, this
2. Subsidiary Ledgers—In order to control the accounting for fixed assets, it is helpful to have a
subsidiary ledger showing each asset recorded in the fixed asset accounts.
3. Depreciation on Low-Cost Assets—Assets that have a low cost (e.g., a wastepaper basket, small hand
