Acc week 6

11

WEEK 6WEEK 6

ACCOUNTING FOR FIXED ACCOUNTING FOR FIXED ASSETASSET

22

In Your Textbook...In Your Textbook...

Roshayani Arshad, et al. (2007), Roshayani Arshad, et al. (2007), Financial Financial Accounting An IntroductionAccounting An Introduction, 2, 2ndnd Edition, Edition, Malaysia, McGraw Hill.Malaysia, McGraw Hill.

Chapter 13: Accounting for Property, Chapter 13: Accounting for Property, Plant and EquipmentPlant and Equipment

33

Nature of Fixed AssetsNature of Fixed AssetsNature of Fixed AssetsNature of Fixed Assets

Fixed assets are long term or relatively permanent assets

Fixed assets are long term or relatively permanent assets

Fixed assets are tangible assets because they exist physically.

Fixed assets are tangible assets because they exist physically.

They are owned and used by the business and are not held for sale

as part of normal operations.

They are owned and used by the business and are not held for sale

as part of normal operations.

44

Classifying CostsClassifying CostsClassifying CostsClassifying Costs

Is the purchased item long-lived?

Yes

Is the asset used in production purpose?

No

Expense

Yes

Fixed Assets

No

Investment

66

Purchase pricePurchase price Sales taxesSales taxes Permits from government Permits from government

agenciesagencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees Razing or removing Razing or removing

unwanted buildingsunwanted buildings

Purchase pricePurchase price Sales taxesSales taxes Permits from government Permits from government

agenciesagencies Broker’s commissionsBroker’s commissions Title feesTitle fees Surveying feesSurveying fees Razing or removing Razing or removing

unwanted buildingsunwanted buildings

LandLandLandLand

77

Architects’ fees Engineers’ fees Insurance Repairs & reconditioning Sales taxes Permits from government

agencies

BuildingsBuildingsBuildingsBuildings

88

Machinery and EquipmentMachinery and Equipment

Sales taxesSales taxes DeliveryDelivery InstallationInstallation Repairs (purchase of Repairs (purchase of

used equipment)used equipment) Reconditioning Reconditioning

(purchase of used (purchase of used equipment)equipment)

InsuranceInsurance

99

The cost of an asset = The cost of an asset = The sum of all the costs incurred to The sum of all the costs incurred to

bring the asset to the location bring the asset to the location and condition necessary for its and condition necessary for its

intended use.intended use.

In a nutshell...In a nutshell...In a nutshell...In a nutshell...

1010

Nature of DepreciationNature of DepreciationNature of DepreciationNature of Depreciation

All fixed assets except land lose their capacityto provide services. This loss of productive

capacity is recognized as Depreciation Expense.

All fixed assets except land lose their capacityto provide services. This loss of productive

capacity is recognized as Depreciation Expense.

Physical depreciation occurs from wear and tear while in use and from the action of the weather.

Physical depreciation occurs from wear and tear while in use and from the action of the weather.

Functional depreciation occurs when a fixed asset is no longer able to provide services at the level for which it was intended, e.g., personal computer.

Functional depreciation occurs when a fixed asset is no longer able to provide services at the level for which it was intended, e.g., personal computer.

1111

Depreciation Expense FactorsDepreciation Expense FactorsDepreciation Expense FactorsDepreciation Expense Factors

Initial Cost Residual Value- = Depreciable Cost

Useful Life

1

Periodic Depreciation Expense

2 3 4 5

1212

The period over which the company The period over which the company expects to derive economic benefits from expects to derive economic benefits from the asset.the asset.

Determined by factors such as Determined by factors such as technological progress and changes in technological progress and changes in demand.demand.

Useful Life of a Fixed AssetUseful Life of a Fixed AssetUseful Life of a Fixed AssetUseful Life of a Fixed Asset

1313

Also known as ‘Scrap Value’.Also known as ‘Scrap Value’.The estimated amount receivable when The estimated amount receivable when

the fixed asset is put out of use by the the fixed asset is put out of use by the business.business.

If there is any estimated residual value, If there is any estimated residual value, need to minus this amount from the cost of need to minus this amount from the cost of fixed asset before calculating the amount fixed asset before calculating the amount of depreciation charged.of depreciation charged.

Residual ValueResidual ValueResidual ValueResidual Value

1414

83%

4%8% 5%

Straight-Line

Reducing- Balance

Other Units-of-Production

Source: Accounting Trends & Techniques, 56th. ed., American Institute of Certified Public Accountants, New York, 2002.

Use of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation MethodsUse of Depreciation Methods

1515

FactsFactsFactsFacts

Original Cost.....………….. RM24,000

Estimated Life in years….. 5 years

Estimated Life in hours….. 10,000

Estimated Residual Value... RM2,000

Original Cost.....………….. RM24,000

Estimated Life in years….. 5 years

Estimated Life in hours….. 10,000

Estimated Residual Value... RM2,000

1616

Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Cost – estimated residual value

Estimated life

= Annual depreciation

1717


RM24,000 – RM2,000

5 years

= RM4,400 annual depreciation

1818


The straight-line method is widely used by firms because it is simple and it

provides a reasonable transfer of cost to periodic expenses if the asset is used

about the same from period to period.

The straight-line method is widely used by firms because it is simple and it

provides a reasonable transfer of cost to periodic expenses if the asset is used

about the same from period to period.

1919

Accum. Depr. Book Value Depr. Book Valueat Beginning at Beginning Expense at End

Year Cost of Year of Year for Year of Year

1 $24,000 $24,000 $4,400 $19,600

2 24,000 $ 4,400 19,600 4,400 15,200

3 24,000 8,800 15,200 4,400 10,800

4 24,000 13,200 10,800 4,400 6,400

5 24,000 17,600 6,400 4,400 2,000

Cost ($24,000) Cost ($24,000) –– Residual Value ($2,000) Residual Value ($2,000)

Estimated Useful Life (5 years)Estimated Useful Life (5 years)=

Annual Annual DepreciationDepreciation

Expense ($4,400)Expense ($4,400)


2020

Reducing Balance MethodReducing Balance Method

The fixed asset depreciates at a fixed The fixed asset depreciates at a fixed percentage.percentage.

The depreciation amount will diminish with every The depreciation amount will diminish with every successive period.successive period.

Formula :-Formula :-

Depreciation Depreciation expense per expense per annum annum

==Rate of Rate of depreciationdepreciation xx

Net Book Value Net Book Value (NBV) of asset(NBV) of asset

2121

Book Value Accum. Beginning Annual Deprec. Book ValueYear of Year Rate Deprec. Year-End Year-End

1 $24,000 40% $9,600

Reducing-Balance MethodReducing-Balance MethodReducing-Balance MethodReducing-Balance Method

$24,000 x .40$24,000 x .40

2222


1 $24,000 40% $9,600 $9,600 $14,400


2323


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760


$14,400 x .40$14,400 x .40

2424


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640


2525


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184


2626


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110


2727


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 40% 1,244 22,134 1,866

STOP!STOP!


2828


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 40% 1,244 22,134 1,866

Reducing-Balance MethodReducing-Balance MethodReducing-Balance MethodReducing-Balance MethodIf we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of

Year 5 is expected to be $2,000, so we must modify our approach.

If we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of

Year 5 is expected to be $2,000, so we must modify our approach.

2929


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 --- 1,110


$3,110 – $2,000$3,110 – $2,000

3030


1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 --- 1,110 22,000 2,000

Desired ending book

value


3131

Comparing Straight-Line With the Comparing Straight-Line With the Reducing-Balance MethodReducing-Balance Method

Comparing Straight-Line With the Comparing Straight-Line With the Reducing-Balance MethodReducing-Balance Method

Straight-LineMethod

Dep

reci

atio

n ($

) 5,000

4,000

3,000

2,000

1,000

0

Life (years)

Declining-BalanceMethod

Life (years) 1 2 3 4 1 2 3 4

3232

16

17

18

19

Accumulated Depreciation—

Office Equipment 4,400 00

Dec. 31 4,400Depreciation Expense

Dec. 31 4,400

Accumulated Depreciation—Office Equipment

53

Depreciation Expense 4,400 0031

Recording Depreciation in the BookRecording Depreciation in the BookRecording Depreciation in the BookRecording Depreciation in the Book

3333

The balance sheet would show the office equipment at

cost, less the accumulated depreciation.

The balance sheet would show the office equipment at

cost, less the accumulated depreciation.

Office equipment $24,000 Less accumulated depreciation 4,400 $19,600

Book Book valuevalue

3434

Alternative MethodAlternative Method

The depreciation expense is debited directly The depreciation expense is debited directly into the P&L account.into the P&L account.

Adjusting entriesAdjusting entries:-:-1.1. Amount charged for the period:-Amount charged for the period:-

Debit Profit & Loss Account.Debit Profit & Loss Account. Credit Accumulated Depreciation Account.Credit Accumulated Depreciation Account.

In this case, the depreciation for the period being posted to the P&L account is being described as “depreciation” and not by the name of the account it is being posted from. This clearly is not the convention usually adopted when posting entries between ledger accounts and is very much ‘the exception to the rule’.

3535

16

17

18

19

Accumulated Depreciation—

Office Equipment 4,400 00

Dec. 31 4,400Profit & Loss a/c

Dec. 31 4,400

Accumulated Depreciation—Office Equipment

53

Profit & Loss 4,400 0031

Recording Depreciation in the Book – Recording Depreciation in the Book – Alternative MethodAlternative Method

Recording Depreciation in the Book – Recording Depreciation in the Book – Alternative MethodAlternative Method

3636

Lecture Exercise 1Lecture Exercise 1On 1 January 2003, Tim bought a machine costing On 1 January 2003, Tim bought a machine costing

$20,000. It was decided that it would be depreciated $20,000. It was decided that it would be depreciated at 20% per annum.at 20% per annum.

Year ended Year ended 31 Dec31 Dec

20032003 20042004 20052005 Accumulated Accumulated Depreciation Depreciation 31 Dec 200531 Dec 2005

Book value Book value of machine of machine on 31 Dec on 31 Dec

20052005

(i) Depn – (i) Depn – Straight line Straight line methodmethod

(ii) Depn – (ii) Depn – Reducing Reducing balance balance methodmethod

3737

Lecture Exercise 1: SolutionLecture Exercise 1: SolutionOn 1 January 2003, Tim bought a machine costing On 1 January 2003, Tim bought a machine costing

$20,000. It was decided that it would be depreciated at $20,000. It was decided that it would be depreciated at 20% per annum.20% per annum.

Year ended Year ended 31 Dec31 Dec

2003 2003 $$

2004 2004 $$

2005 2005 $$

Accumulated Accumulated Depreciation Depreciation 31 Dec 2005 31 Dec 2005

$$

Book value Book value of machine of machine on 31 Dec on 31 Dec 2005 ($)2005 ($)

(i) Depn – (i) Depn – Straight line Straight line methodmethod

4,0004,000 4,0004,000 4,0004,000 12,00012,000 8,0008,000

(ii) Depn – (ii) Depn – Reducing Reducing balance balance methodmethod

4,0004,000 3,2003,200 2,5602,560 9,7609,760 10,24010,240

3838

MedLab Bhd., a manufacturer of lozenges, purchased a new MedLab Bhd., a manufacturer of lozenges, purchased a new piece of equipment which was priced at RM400,000 from piece of equipment which was priced at RM400,000 from an equipment manufacturer. an equipment manufacturer.

Transportation costs involved amounted to RM1,000 while the Transportation costs involved amounted to RM1,000 while the

insurance against damage for the equipment amounted to insurance against damage for the equipment amounted to RM400. Installation costs amounted to RM8,600. RM400. Installation costs amounted to RM8,600.

MedLab Bhd uses the straight-line method for calculating MedLab Bhd uses the straight-line method for calculating depreciation. Assume that the equipment can be used for depreciation. Assume that the equipment can be used for 8 years and the salvage value is estimated to be 8 years and the salvage value is estimated to be RM10,000. The company’s financial year ends on the 31st RM10,000. The company’s financial year ends on the 31st of December each year. of December each year.

Calculate the depreciation charges and prepare the adjusting Calculate the depreciation charges and prepare the adjusting journal entries at the end of its accounting years.journal entries at the end of its accounting years.

Lecture Exercise 2Lecture Exercise 2

3939

Annual depreciation: (RM410,000 – RM10,000)/8 Annual depreciation: (RM410,000 – RM10,000)/8

= RM50,000= RM50,000

Journal entries:Journal entries:

31 Dec Depreciation expense31 Dec Depreciation expense RM50,000RM50,000

Provision for DepreciationProvision for Depreciation RM50,000RM50,000

Cost of fixed assets:Cost of fixed assets: RMRM

Invoice price of equipmentInvoice price of equipment 400,000400,000

Transportation costsTransportation costs 1,0001,000

Insurance chargesInsurance charges 400400

Installation costsInstallation costs 8,6008,600

410,000410,000

Lecture Exercise 2: SolutionLecture Exercise 2: Solution

4040

Accounting for Fixed Asset DisposalsAccounting for Fixed Asset DisposalsAccounting for Fixed Asset DisposalsAccounting for Fixed Asset Disposals

When fixed assets lose their usefulness they When fixed assets lose their usefulness they may be disposed of in one of the following may be disposed of in one of the following ways:ways:

1. 1. discardeddiscarded,,2. 2. soldsold, , oror3.3. tradedtraded (exchanged) for similar assets. (exchanged) for similar assets.

An An assetasset accountaccount mustmust bebe creditedcredited toto removeremove thethe assetasset fromfrom the ledger, and the related the ledger, and the related Accumulated DepreciationAccumulated Depreciation account must be account must be debiteddebited to remove it’s balance from the ledger. to remove it’s balance from the ledger.

4141

When fixed assets are sold, the owner may break even, sustain a loss, or realize a gain.

1.1. If the sale price is If the sale price is equal to book valueequal to book value, there , there will be will be no gain or lossno gain or loss..

2.2. If the sale price is If the sale price is less than book valueless than book value, there , there will be a will be a lossloss equal to the difference. equal to the difference.

3.3. If the sale price is If the sale price is more than book valuemore than book value, , there will be a there will be a gaingain equal to the difference. equal to the difference.

Sale of Fixed AssetsSale of Fixed AssetsSale of Fixed AssetsSale of Fixed Assets

4242


Equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The

equipment is sold for cash on October 1. Accumulated Depreciation (last adjusted December 31) has a balance of $7,000.

Equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The

equipment is sold for cash on October 1. Accumulated Depreciation (last adjusted December 31) has a balance of $7,000.

Oct. 1 Depreciation Expense—Equipment 750 00

Accumulated Depr.—Equipment 750 00

$10,000 x ¾ $10,000 x ¾ x10%x10%

$10,000 x ¾ $10,000 x ¾ x10%x10%

4343


Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.

Assumption 1: The equipment is sold for $2,250, so there is no gain or loss.

Oct. 1 Cash 2 250 00

Accumulated Depr.—Equipment 7 750 00

Equipment 10 000 00

4444


Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.

Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250.

Oct. 1 Cash 1 000 00


Equipment 10 000 00

Loss on Disposal of Fixed Assets 1 250 00

4545


Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.

Assumption 2: The equipment is sold for $2,800, so there is a gain of $550.

Equipment 10 000 00 Gain on Disposal of Fixed Assets 550 00


Oct. 1 Cash 2 800 00

4646


Grace Bakery bought a new oven on 1Grace Bakery bought a new oven on 1stst January January 2005 for RM200,000. It was decided that 2005 for RM200,000. It was decided that depreciation is at 10%p.a. on cost. Accumulated depreciation is at 10%p.a. on cost. Accumulated depreciation up to 31depreciation up to 31stst December 2007 will be December 2007 will be RM60,000. If the oven is sold at RM100,000 on RM60,000. If the oven is sold at RM100,000 on 3131stst December 2007, show the relevant journal December 2007, show the relevant journal and ledger entries.and ledger entries.

4747

Lecture Exercise 3 SolutionLecture Exercise 3 Solution

Journal entries:Journal entries:

Dr Disposal a/cDr Disposal a/c RM200,000RM200,000

Cr Equipment a/cCr Equipment a/c RM200,000RM200,000

Dr Acc. depreciation a/cDr Acc. depreciation a/c RM60,000RM60,000

Cr Disposal a/cCr Disposal a/c RM60,000RM60,000

4848

Dr Bank a/cDr Bank a/c RM100,000RM100,000

Cr Disposal a/cCr Disposal a/c RM100,000RM100,000

Dr Inc.–loss on disposalDr Inc.–loss on disposal RM40,000RM40,000

Cr Disposal a/cCr Disposal a/cRM40,000RM40,000

4949

Alternatively:Alternatively:Dr Acc. DepreciationDr Acc. Depreciation RM60,000RM60,000

Bank a/cBank a/c RM100,000 RM100,000 Inc. statement-loss on disp.Inc. statement-loss on disp. RM40,000RM40,000

Cr Equipment a/cCr Equipment a/c RM200,000RM200,000

Ledger entries:Ledger entries:

RM RMBalance b/d 200,000 Disposal 200,000

Equipment Account

5050

RM RMDisposal 60,000 Balance b/d 40,000

Depreciation a/c 20,00060,000

Acc. Depreciation Account

RM RMAcc. Dep. a/c 20,000 Inc. statement 20,000

Depreciation Account

5151

RM RMEquipment a/c 200,000 Acc. Dep. a/c 60,000

Bank-sale proceeds 100,000Income Statement-loss on disposal 40,000

200,000 200,000

Disposal Account

5252

Glad Bhd purchased a machine on 1Glad Bhd purchased a machine on 1stst January January 2003 for RM60,000. It was sold on 312003 for RM60,000. It was sold on 31stst December 2005 for RM30,000. The asset was December 2005 for RM30,000. The asset was depreciated using the straight line method. It depreciated using the straight line method. It was extimated to have a useful life of 5 years was extimated to have a useful life of 5 years and a scrap value of RM20,000. On 31and a scrap value of RM20,000. On 31stst December 2005, accumulated depreciation December 2005, accumulated depreciation amounted to RM24,000.amounted to RM24,000.

Show the relevant journal and ledger entries to Show the relevant journal and ledger entries to effect the sale of this asset.effect the sale of this asset.


Business

Acc week 6