Notes on Fixed Assets, Depreciation, and Intangibles

Fixed Assets

• Definition:
  • Long-term, relatively permanent assets.
  • Tangible resources (physical substance).
  • Used in business operations (>1 year).
  • Not held for sale (productive assets).
  • Recorded at cost.
• Other Names:
  • Property, Plant, & Equipment (PP&E).
  • Plant & Equipment.
  • Plant Assets.

Costs of Acquiring Fixed Assets

• Building Costs:

  • Architects' and engineers' fees.
  • Insurance during construction.
  • Interest on borrowed funds for construction.
  • Costs for walkways, sales taxes, repairs, reconditioning, modifications, and permits.

• Machinery & Equipment Costs:

  • Includes sales taxes, freight, installation, insurance in transit, reconditioning, assembly, and government permits.

• Land and Land Improvements Costs:

  • Purchase price, sales taxes, permits, broker's commissions, title fees, surveying fees.
  • Removing unwanted buildings (less salvage), grading, paving streets, trees, shrubs, paved parking areas, outdoor lighting, and fences.

Depreciation

• Definition:

  • Allocation of the cost of a fixed asset as an expense over its useful life.
  • Systematic and rational method to match expenses with revenues.

• Effects on Financial Statements:

  • Income Statement: Depreciation Expense.
  • Balance Sheet: Accumulated Depreciation (contra-asset).

• Net Book Value:

  • Formula: Cost - Accumulated Depreciation.
  • Not representative of market value.

Depreciable Assets

• Categories:

  • Land improvements, buildings, equipment, machinery, automobiles.
  • Not Depreciable: Land.

• Factors Affecting Depreciation:

  • Wear and tear, obsolescence decreases revenue-producing ability.

Depreciation Methods

1. Straight-Line Method

• Calculation:

  • Annual Depreciation = (Cost - Residual Value) / Useful Life.

• Example:

  • For a $24,000 asset with a $2,000 residual value over 5 years:
  • Annual Depreciation = ($24,000 - $2,000) / 5 = $4,400.

2. Double-Declining-Balance Method

• Overview:

  • Accelerated depreciation method.
  • Formula:
  • DDB Rate = (Straight-Line Rate) * 2.
  • Depreciation Expense = DDB Rate * Net Book Value.

• Example Calculation:

  • Initial Cost = $24,000, Residual Value = $2,000, Useful Life = 5 years.

Tax Considerations

• IRS allows depreciation for tax deductions.
• Different methods for taxes vs financial statements:
  • Common methods include Straight-line and MACRS (Modified Accelerated Cost Recovery System).

Partial Year Depreciation

• General Rule:
  • Prorated based on when the asset was put into service.
  • Applies to both Straight-Line and Double-Declining Balance methods.

Additional Costs Post-Purchase

• Capital Expenditures:

  • Extraordinary repairs and improvements; extends useful life.

• Revenue Expenditures:

  • Routine maintenance, primarily benefits the current period.

Asset Disposal

• Methods of Disposal:

  • Sold, exchanged, or retired.
  • Record depreciation expense, compute net book value, and remove asset & accumulated depreciation.

• Gains and Losses:

  • Gain on disposal = Selling Price > Book Value.
  • Loss on disposal = Selling Price < Book Value.

• Example:

  • Discarding fully depreciated assets with no remaining value accounting for depreciation.

Natural Resources and Depletion

• Depletion:

  • Exemplified by natural resources like timber, minerals.
  • Cost transfer to expense account based on extraction rates.

• Calculation:

  • Depletion Expense = Depletion Rate * Quantity Extracted.

Intangible Assets

• Characteristics:

  • No physical substance; rights or competitive advantages.
  • Recorded at cost; amortized over useful life (if limited).

• Patents:

  • Exclusive rights to produce/sell; amortization usually over the life of the patent.

• Goodwill:

  • Created from favorable business factors; assessed for impairment, not amortized.

Financial Statement Effects for Intangible Assets

• Recording and amortizing effect on statements of income and stockholder equity as applicable.