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Blueprint Problem: Fixed Assets and Straight-line Depreciation Nature and Measurement of Fixed Assets Fixed assets are assets with long lives (greater than one year) that are used in the normal operations of a business to generate revenue. These assets are tangible assets with a limited life (except for land) that are not intended for resale. A fixed asset should be recorded at its cost. This cost includes not only the purchase price but also any expenditures necessary to prepare it for its intended use. Costs that do not increase the asset's usefulness or are recurring in nature should not be included. If several fixed assets are purchased as a group, the cost of each asset purchased must be measured and recorded separately. An example of a fixed asset would be . Fixed assets are reported on Select the in the Select section. Select Expenditures necessary to purchase and prepare a fixed asset for its intended use are Select . Fixed assets purchased as a group should have Select . Which of the following should be included in the cost of a fixed asset. Commissions Select Sales taxes Select Closing costs Select Transportation costs Select Damage during setup Select Annual licensing Select The Nature and Measurement of Depreciation Depreciation is 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 to earn. All fixed assets are depreciated with one exceptionland. Depreciation is recorded with a debit to Depreciation Expense (an expense) and a credit to Accumulated Depreciation (a contra-asset). The difference between the historical cost of the asset and its accumulated depreciation is known as the asset's book value. The acquisition cost must be accurately measured; the useful life and the salvage value must be estimated to calculate depreciation. The difference between the cost of the asset and the salvage value is known as the depreciable cost. The depreciable cost is the amount that will be expensed over the asset's life. Consider this: At the purchase date, the book value of an asset is equal to the Select . Determine whether the following statements are true or false. Depreciation is an example of the matching principle. Select Accumulated Depreciation is a permanent account. Select Straight-Line Depreciation The straight-line method spreads the depreciable cost of an asset evenly over its useful life. It is the simplest method to calculate depreciation expense. Simply divide the asset's depreciable cost by its useful life, in years. The result is the annual depreciation expense, which is also the amount by which accumulated depreciation increases each year. The formula to compute the depreciation expense under the straight line method is as follows: Annual Depreciation Expense = Depreciable Cost Useful Life Assume that a truck has an acquisition cost of $31,500. Its useful life is estimated to be five years, and the estimated salvage value is $1,500. Depreciation expense is calculated as follows: $6,000 = ($31,500 - $1,500) 5 years The annual depreciation amount works out nicely for assets purchased at the beginning of the period. But what if an asset is purchased sometime during the year, other than on the first day? Under the matching principle, depreciation can only be recognized for the portion of the year that the asset was in service. When this happens, a partial year's depreciation must be calculated. The annual depreciation expense for the first year is proratedpart being recognized in the first year, the remainder to be recognized in the final year. Therefore, when an asset is purchased midyear, the sum of first and final years' depreciation is equal to one full year's depreciation. Keep in mind that the total depreciation expense that can be recognized over the life of the asset is its depreciable cost. This means that the balance in Accumulated Depreciation can never exceed depreciable cost. + Partial year's depreciation APPLY THE CONCEPTS: Measure and record the purchase of a fixed asset On July 1, 2011, Galaxy Sun Industries purchased new equipment from Acme Equipment Company that had a purchase price (including sales tax) of $112,125. Acme charged $2,500 to deliver the equipment and $10,000 to install it at Galaxy Sun's site. Galaxy Sun's accountant provided the payment for the equipment, delivery, and installation to Acme that day. Galaxy Sun had its own master-level employees perform trial runs on the equipment. This took 12.5 hours, and those employees earn $30 per hour. During the trial runs, there was some damage to one of the walls beside the equipment. Galaxy Sun's maintenance staff repaired the wall. The cost for the maintenance wages was $125. All wages for trial runs and wall repair will be paid at the end of the following week. Which of the following costs that Galaxy Sun will capitalize as part of the cost of the equipment? $375 Select $10,000 Select $2,500 Select $112,125 Select $125 Select Which of the following costs that Galaxy Sun will expense immediately? $125 Select $375 Select $10,000 Select $2,500 Select $30 Select Hide Prepare the journal entry to record the purchase of the equipment. Not sure about the account title? Click here to view the chart of accounts. + Assets + Liabilities + Equity + Revenues/Gains + Expenses/Losses GENERAL JOURNAL page DATE 1 DESCRIPTION DOC. NO. POST. REF. DEBIT CREDIT J ul 1/ 1 Jul 1 2 2 3 3 4 4 5 5 How does each row of the above journal entry affect the accounting equation, and on which financial statement is it reported? If it is not affected then select "No effect" as correct answer. R Assets =Liabilities +Equity Appears on: o w 1. Select Select Select Select 2. Select Select Select Select 3. Select Select Select Select 4. Select Select Select Select APPLY THE CONCEPTS: Calculate and determine the entry for straight-line depreciation The equipment purchased by Galaxy Sun Industries (see the journal entry above) is expected to have a useful life of four years. At the end of its useful life, the residual value of the equipment is estimated to be $7,000. Galaxy Sun Industries's fiscal year ends each December 31. In the table to the below, calculate the equipment's depreciation expense, the balance of accumulated depreciation, and the book value for each year the equipment is expected to be in service, using the straight-line method. Straight-Line Method Year Depreciation Expense Accumulated Depreciation Book Value 2011 $ $ $ 2012 $ $ $ 2013 $ $ $ 2014 $ $ $ 2015 $ $ $ Galaxy Sun prepares the entry to record depreciation each year on December 31. The accounts affected are Depreciation Expense and Accumulated Depreciation. Indicate how is the journal entry recorded, what effect does the entry have on the accounting equation, and on which financial statement is it reported in the table below. If it is not affected then select "No effect" as correct answer. Account Debit or Credit Assets = Liabilities + Equity Appears on: Deprecia tion Expense Select Select Select Select Select Accumul ated Deprecia tion Select Select Select Select Select 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 a fixed asset. The historical cost principle is applied to fixed assets. A fixed asset should be recorded at its cost, which includes any expenditures necessary to prepare it for its intended use. The cost of a fixed asset, except for the cost of 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 a 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 section of Select the . Fixed assets with different useful lives but purchased as a group Select must have . Land has an indefinite life and is classified Select as . Select 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 $170,000. The fair market value of the assets are shown in the table below. Determine each asset's percentage of fair market value total. Then, apply that percentage to the group purchase cost to determine the allocated cost to be recorded for each asset. Fair market value Percent of total Allocated cost Land $88,400 % $ Building 121,550 % $ 11,050 % $ Truck Total $ 100% $170,000 The Nature and Measurement of Depreciation Depreciation is 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 exceptionland. Depreciation is recorded with a debit to Depreciation Expense (an expense) and a credit to Accumulated Depreciation (a contra-asset). The difference between the historical cost of the asset and its accumulated depreciation is known as the asset's book value. The acquisition cost must be accurately measured; the useful life and the salvage value must be estimated to calculate depreciation. The difference between the cost of the asset and the salvage value is known as the depreciable 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 account. Select 2. Acquisition cost less salvage is Select 3. At the end of an asset's useful life, book value will be equal to the Select Hide Declining Balance Depreciation The declining balance method is 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) of the 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 equal 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.) Click here to view an example of the declining-balance method. 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, Input Outzone Inc. acquired a new piece of machinery and a used truck from Acme Equipment Company. Input Outzone negotiated a price of $120,000 for both items. The fair market value of the equipment was $120,000, and the fair market value of the truck was $30,000. Input Outzone Inc. 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. Not sure about the account title? Click here to view the chart of accounts. + Assets + Liabilities + Equity + Revenues/Gains + Expenses/Losses GENERAL JOURNAL page DATE 1 ACCOUNT TITLE 1/1 Jan. 1 DOC. NO. POST. REF. DEBIT CREDIT 1 2 2 3 3 How does each row of the above journal entry affect the accounting equation, and on which financial statement is it reported? If it is not affected then select "No effect" as correct answer. Ro Assets = Liabilities + Equity Appears on: w 1. Select Select Select Select 2. Select Select Select Select 3. Select Select Select Select APPLY THE CONCEPTS: Calculate and determine depreciation using the declining balance method The machine purchased by Input Outzone Inc. (see journal entry above) is expected to have a useful life of four years. At the end of its useful life, the salvage value of the machine is estimated to be $7,000. Input Outzone Inc.'s fiscal year ends each December 31. The company has elected to depreciate the machine using the declining balance method at two times the straight-line rate. Using the data above, calculate the depreciation rate for the machine: Depreciation Rate = X %= % Complete the table below: Declining Balance Method Year Depreciation expense 2011 $ $ $ 2012 $ $ $ 2013 $ $ $ 2014 $ $ $ Consider this: Accumulated depreciation Book value Assume that a company purchases a fixed asset on January 1 and does not record the purchase at all, nor does it record the depreciation each year. How would this affect net income for each year of the asset's useful life? Select Transactions for Fixed Assets, Including Sale The following transactions, adjusting entries, and closing entries were completed by King Furniture Co. during a three-year period. All are related to the use of delivery equipment. The double-declining-balance method of depreciation is used. 2012 Jan. 4. Purchased a used delivery truck for $48,600, paying cash. Feb. 24. Paid garage $200 for changing the oil, replacing the oil filter, and tuning the engine on the delivery truck. Dec. 31. Recorded depreciation on the truck for the fiscal year. The estimated useful life of the truck is 9 years, with a residual value of $10,200 for the truck. 2013 Jan. 3. Purchased a new truck for $55,860, paying cash. Mar. 7. Paid garage $260 to tune the engine and make other minor repairs on the used truck. Apr. 30. Sold the used truck for $33,600. (Record depreciation to date in 2013 for the truck.) Dec. 31. Record depreciation for the new truck. It has an estimated trade-in value of $10,100 and an estimated life of 7 years. 2014 July 1. Purchased a new truck for $88,000, paying cash. Oct. 7. Sold the truck purchased January 3, 2013, for $33,050. (Record depreciation to date in 2014 for the truck.) Dec. 31. Recorded depreciation on the remaining truck. It has an estimated residual value of $15,800 and an estimated useful life of 10 years. Required: Hide Journalize the transactions and the adjusting entries. For a compound transaction, if an amount box does not require an entry, leave it blank. Do not round intermediate calculations. Journal titles Choices are: Accounts Payable, Accumulated Depreciation, Cash, Delivery Truck, Truck Repair Expense 20 12 Jan. 4 Fe b. 24 De c. 31 20 13 Jan. 3 Ma r. 7 Apr . 30Dep rec. Apr . 30Sal e De c. 31 20 14 July 1 Oct . 7Dep rec. Oct . 7Sal e De c. 31