Dire Dawa University

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

FUNDAMENTAL OF ACCOUNTING II
by
MIKIYAS NIGUSSIE
Contact Address:
mikiyasnigussie8@gmail.com

MAY , 2022

MIKIYAS NIGUSSIE 1
 Chapter 2

Fixed and Intangible Assets

2
 Objectives
1. Define fixed assets and describe the accounting for their cost.
2. Compute depreciation, using the following methods: straight-
After studying this
line method, units-of-production chapter,
method, and declining-
balance method. you should be able to:
3. Classify fixed asset costs as either capital expenditures or
revenue expenditures.
4. Journalize entries for the disposal of fixed assets.
5. Define a lease and summarize the accounting rules related to
the leasing of fixed assets.

3
 Objectives
6. Describe internal controls over fixed assets.
7. Compute depletion and journalize the entry for depletion.
8. Describe the accounting for intangible assets, such as patents,
copyrights, and goodwill.
9. Describe how depreciation expense is reported in an income
statement, and prepare a balance sheet that includes fixed
assets and intangible assets.
10. Compute and interpret the ratio of fixed assets to long-term
debt.

4
 Nature of Fixed Assets

Fixed assets are long term or relatively

permanent assets
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.
5
Property, Plant, and Equipment are long-lived assets that the
company owns and uses for the production and sale of goods or
services to consumers. Property, plant, and equipment are also
commonly known as fixed assets; land, building, and equipment;
or capital assets CHARACTERSTICS
have a physical substance
are held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes
are not intended for sale to customers.
 Long-term assets are divided into tangible and intangible
categories
7
Determining Cost of Property, Plant, and Equipment

1. The purchase price, plus any non-refundable taxes, less any
discounts or rebates;
2. The expenditures necessary to bring the asset to the required
location and make it ready for its intended use; and
3. Any obligations to dismantle, remove, or restore the asset when
it is retired.
All of the above-mentioned expenditures are capitalized (recorded
as property, plant, and equipment), rather than expensed, if it is
probable that the company will receive an economic benefit in the
future from the asset.
 Costs that benefit only the current period are expensed. Such
costs are called operating expenditures.
Costs that benefit future periods are included in a long-lived
asset account. These costs are called capital expenditures.
JJ & Company purchased equipment for its factory; the equipment is expected to be used for 10 years. Illustration 2.1 summarize the cost incurred.

Description of expenditure Amount Expenditure type

Purchase price $100,000 Capital expenditure
Shipping 8,000 Capital expenditure
Insurance while the 1,200 Capital expenditure
equipment was in transit

Installation in factory 3,500 Capital expenditure

Total $112,700
Description of Amount Expenditure type
expenditure
Oil and lubrication $ 160 Operating expenditure

Repairs required 1,600 Operating expenditure

because of normal wear
and tear

Total $1,760
1760
 Land

• Purchase price
• Sales taxes
• Permits from government agencies
• Broker’s commissions
• Title fees
• Surveying fees

11
 Land

• Purchase price
• Delinquent real estate taxes
• Sales taxes• Razing or removing unwanted buildings,
• Permits fromless
government agencies
the salvage
• Broker’s commissions
• Grading and leveling
• Title fees • Paving a public street bordering the land
• Surveying fees

12
Buildings

 Architects’ fees
 Engineers’ fees
 Insurance costs incurred during
construction
 Interest on money borrowed to
finance construction
 Walkways to and around the
building
13
Buildings
 Sales taxes
 Repairs (purchase of existing
building)
 Reconditioning (purchase of an
existing building)
 Modifying for use
 Permits from governmental
agencies
14
 Land Improvements
• Trees and shrubs
• Fences
• Parking areas
• Outdoor lighting
• Concrete sewers and drainage
• Paved parking areas

15
Machinery and Equipment
• Sales taxes
• Freight
• Installation
• Repairs (purchase of used
equipment)
• Reconditioning (purchase
of used equipment)

16
Machinery and Equipment
• Insurance while in transit
• Assembly
• Modifying for use
• Testing for use
• Permits from governmental
agencies

17
These costs are treated as capital expenditures because they
benefit future periods and are necessary to bring the asset to
its required location and make it ready for use.
Depreciation
is the systematic allocation of the cost of a long-lived asset,
such as property, plant, and equipment, over the asset’s useful
life. The cost is allocated to expense over the asset’s useful life
to recognize the cost that has been used up (the expense) during
the period, and report the unused cost (the asset) at the end of
the period. Depreciation is recorded through an adjusting
journal entry that debits Depreciation Expense and credits
Accumulated Depreciation.
It is important to understand that depreciation is a process of
cost allocation, not a process of determining an asset’s real value
 Depreciation Expense Factors

Initial Cost - Residual Value = Depreciable Cost

Useful Life

1 2 3 4 5

Periodic Depreciation Expense

20
 Cost- is the net purchase price plus all reasonable and necessary expenditures to get the asset in place
and ready for use.
 Residual value- also known as salvage value, disposal value, scrape value, or trade-in value
represents the estimated market value of the asset at the time of its retirement.
 Depreciable cost - represents the difference between the asset cost and its estimated residual value.
For example, an item of equipment that costs Br. 5000 and has a residual value of Br. 500 would
have a depreciable cost of Br. 4500, (Br. 5000 - Br. 500). The depreciable costs must be allocated
over the estimated economic life of the asset.
 Estimated economic (useful) life- the estimated economic life of an asset is the total number of
service units expected from the asset. Service units may be measured in terms of years the asset is
expected to be used, units expected to be produced, miles or kilometers expected to be driven, or
similar measures. In determining the estimated useful life of an asset, the accountant should consider
all relevant information, including (1) past experience with similar repair assets,
 (2) the asset’s present condition,
 (3) the company’s repairs and maintenance policy,
 (4) current technological and industry trends, and
 (5) local conditions such as whether.
 Use of Depreciation Methods

Other Units-of-Production
Declining- 8% 5%
4%
Balance

83%
Straight-Line

Source: Accounting Trends & Techniques, 56th. ed., American Institute of Certified Public
Accountants, New York, 2002.
22
Straight-Line Depreciation

 When this method is used to allocate depreciation, the

depreciable cost of the asset is spread evenly (uniformly)
over the useful life of an asset. The straight-line method is
based on the assumption that depreciation depends only on
the passage of time. The depreciation expense for each
period is computed by dividing the depreciable cost by the
number of accounting periods in the asset’s estimated useful
life.
 Facts(Example)

Original Cost.....………….. $24,000

Estimated Life in years….. 5 years
Estimated Life in hours….. 10,000
Estimated Residual Value... $2,000

24
 Straight-Line Method

Cost – estimated residual value

Estimated life
= Annual depreciation

25
 Straight-Line Method

$24,000 – $2,000
5 years
= $4,400 annual depreciation

26
 Straight-Line Rate

$24,000 – $2,000
= $4,400
5 years

$4,400
= 18.3%
$24,000

27
 Straight-Line Method

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.

28
 Straight-Line Method
Accum. Depr. Book Value Depr. Book Value
at 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) – Residual Value ($2,000) Annual Depreciation

= Expense ($4,400)
Estimated Useful Life (5 years)

29
 Units-of-Production Method

Cost – estimated residual value

Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.

30
 Units-of-Production Method

$24,000 – $2,000
10,000 hours
= Depreciation perper
= $2.20 unit, hour, etc.
hour

31
 Units-of-Production Method
The units-of-production method is more
appropriate than the straight-line method
when the amount of use of a fixed asset
varies from year to year.

32
Declining-Balance Method

Step 1

Ignoring residual value, determine the

straight-line rate
$24,000 – $2,000
= $4,800
5 years
$4,800
= 20%
$24,000
33
Declining-Balance Method

There’s a shortcut. Simply divide one by

the number of years (1 ÷ 5 = .20).

34
 Declining-Balance Method

Step 2

Double the straight-line rate.

.20 x 2 = .40

For the first year, the cost of the asset is multiplied by 40

percent. After the first year, the declining book value of the
asset is multiplied 40 percent.
35
Declining-Balance Method

Step 3

Build a table.

36
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600

$24,000 x .40

37
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400

38
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760

$14,400 x .40

39
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640

40
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
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

41
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
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

42
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
1 STOP!40%
$24,000 $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

43
 Declining-Balance Method
BookIfValue Accum.
we use this approach in Year 5, we will end the year with
Beginning Annual Deprec. Book Value
a book value of $1,866. Remember, the residual value at the
Year of Year Rate Deprec. Year-End Year-End
end of Year 5 is expected to be $2,000, so we must modify
1 $24,000 40% $9,600 $9,600 $14,400
our approach.
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

44
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
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

45
 Declining-Balance Method
Book Value Accum.
Beginning Annual Deprec. Book Value
Year of Year Rate Deprec. Year-End Year-End
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
46
Comparing Straight-Line With the Declining-Balance
Method
Straight-Line Declining-Balance
Method Method
5,000
Depreciation ($)

4,000

3,000

2,000

1,000

0 1 2 3 4 1 2 3 4
Life (years) Life (years) 47
 Depreciation – Method of Cost Allocation

Decreasing-Charge Methods Illustration 2-2

Stanley Coal Mines

Facts

Sum-of-the-Years’-Digits. Each fraction uses the sum of the years as a denominator (5 + 4 + 3 + 2

+ 1 = 15). The numerator is the number of years of estimated life remaining as of the beginning of
the year.

Alternate sum-of-the-years’ n(n+1) 5(5+1)

= = 15
calculation 2 2
LO483
 Depreciation – Method of Cost Allocation

Sum-of-the-Years’-Digits Illustration 2-3

LO 3 Compare activity, straight-line, and decreasing-charge methods of depreciation.

49
Depreciation of partial years
 So far, the illustrations of the depreciation methods have assumed that
the plant assets were purchased at the beginning or end of the accounting
period. However, business does not often buy assets exactly at the
beginning or end of the accounting period. In most cases, they acquire
the assets when they are needed and sell or discard them when they are
no longer useful or needed. The time of year is normally not a factor in
the decision. Thus, it is often necessary to calculate depreciation for
partial years.
 Assume that a piece of equipment is purchased for Br. 5000 and that it
has an estimated useful life of five years, and an estimated residual value
of Br. 500. Assume further that the equipment is purchased on October 2
and that the yearly accounting period ends on December 31.
Annual depreciation = Original cost – Estimated Salvage value
Estimated useful life
= Br. 5000 – Br. 500 = Birr 900
5 years
Depreciation for partial year (Oct – Dec. 31) is therefore, Br. 900 x 3/12 = Br. 225
If the company used the double declining balance method on the above equipment, the
depreciation on the asset would be: Br. 5000 x 40/100 x 3/12, = Br. 500, depr. For three
months,
If the company used the sum-of-years-digits method, the depreciation on the asset would be:
Birr (5000 – 500) x 5/15 x 3/12 = Birr 375, and the depreciation for the second year would
be:

(5000 – 500) x 5/15 x 9/12 = Br. 1125

(5000 – 500) x 4/15 x 3/12 = 300
Therefore, total 2nd year depreciation Br. 1425
Capital Expenditures- are expenditures that improve the operating
efficiency (or capacity) or costs incurred to achieve greater future benefits.
 In addition to the acquisition of plant assets, capital expenditures included
additions and betterments.
 An addition is an enlargement to the physical layout of a plant asset.
Suppose , if a new wing is added to a building, the benefits from the
expenditure will be received over several years, and the amount paid for it
should be debited to the asset account.
 A betterment, on the other hand, is an improvement that does not add to
the physical layout of the asset. Installation of an air conditioning system
is an example of betterment, Replacement of a concrete floor for a wooden
floor is also betterment that will provide benefits over a number of years,
so its cost should be charged (debited) to an asset account.
DISPOSAL OF PLANT ASSETS
A plant asset rarely lasts exactly as long as its estimated life. If it
lasts longer than its estimated life, it is not depreciated past the point
at which its carrying value equals its residual value. The purpose of
depreciation is to spread the depreciable cost of the asset over the
economic life of the asset. Thus, the total accumulated depreciation
should never exceed the total depreciable cost. If the asset is still
used in the business beyond the end of its estimated life, its cost and
accumulated depreciation remain in the ledger accounts.
A plant asset may be disposed by:
(1) Discarding it as worthless; (2) Selling it; or (3) Trading it in on a
new asset
Discarding
If a plant asset is of no further use to the business and cannot be sold or traded,
then the plant asset is discarded. If the asset has no book value. (i.e., if it is fully
depreciated), the plant asset account is credited for the amount of the original cost
of the item being discarded.
At the same time, the accumulated depreciation account is debited for the amount
of the total accumulated depreciation of the item being discarded.
In this case neither gain nor loss is realized.
 for example, on July 5, year 5, equipment that was acquired On Jan 10, year 1, at
a cost of Br. 11,000, is discarded as worthless. The discarded equipment has a
carrying value of Br. 2000 at the time of disposal. The carrying value is computed
as the difference between the cost of asset Br. 11,000 and accumulated
deprecation, Br. 9000. A loss equal to the carrying value should be recorded when
the equipment is discarded.
The journal entry required to discard the plant asset as of July
5, year 5, is:
Year 5
July 5. Acc/Deprecation, Equipment………9000.00
loss on disposal of plant Ass……………2000.00
Equipment...……………………….11000.00
 Discarding Equipment no longer used in the
business
Sale of plant asset
The entry to record the sale of an asset for cash is similar to the one illustrated
above except that the receipt of cash should also be recorded. The following
entries show how to record the sale of equipment under three assumptions
about the selling price. In the first case, the Br. 2000 cash received is exactly
equal to the book value of the equipment (which is equal to Br. 2000).
Case 1. Sold at an amount equal to Book value, Br. 2000, no gain or loss results.
Year 5
July 5. Cash ……………………………2000.00
Accumulated Depreciation, Equip……...9000.00
Equipment…………………………………….11000.00
Sale of equipment at an amount equal to book value
Case 2;
Sold at Br. 1500 cash; Loss of Br. 500, (BV = Br. 2000)
Year 5
July 5. Loss on sale of equipmen…………….500.00
Accumulated Depreciation……… 9000.00
Cash ……………………………….1500.00

Equipment………………………………………….11000.00
Sale of equipment at less than the book value. Loss of Br. 500
Sold at Br. 3000 cash; gain of Br. 1000, cash received through
Sale less book value of the asset (Br. 3000 – Br. 2000)
Year 5 July 5.
Cash …………………………………….3000.00
Accumulated Depr, Equipment…………9000.00
Equipment…………………………………………..11000.00
Gain on sale of plant asset………..…………...1000.00
Sale of equipment at more than the book value; gain of Br. 1000,
(Br. 3000 – Br.2000) recorded
Recording Exchange of Plant Assets
Businesses also dispose of plant assets by trading them in on the
purchase of other plant assets. Exchanges may involve similar
assets, such as an old machine traded-in on a newer model, or
dissimilar assets, such as a machine traded-in on a truck. In either
case, the purchase price is reduced by the amount of the trade-in
allowance.
The basic accounting for exchanges of plant assets is similar to
accounting for sales of plant assets for cash.
. Both Gains and Losses are recognized when a company
exchanges dissimilar assets
For financials reporting purposes, gains on exchanges of similar assets are not
recognized because the earning lives of the asset surrendered are not considered to be
completed.
Loss Recognized on the Exchange
A loss is recognized for financial reporting purposes on all exchange in which a
material loss occurs.
Illustration-2
To illustrate the recognition of a loss, assume that the business exchange a machine
with a cost of Br. 11,000, and accumulated depreciation of Br. 9000 for a newer more
modern machine on the following terms:

Cost of new machine ………………………Birr 12000.

Trade-in Allowance for old machine……………(1500)
Cash payment required (Boot)……………..Birr 10500.
Solution
In the illustration above, the trade-in allowance (1500) is less than the carrying
value (Br. 2000) of the old machine. The loss on the exchange is Br. 500, (Br.
2000 – Br. 1500). Therefore, the journal entry required to record the exchange
of assets would be as follows:

Year 5.
July 5. Equipment (New)……………………..12,000.00
Accum. Depreciation-Equip…………………...9,000.00
Loss on Exchange of plant assets………………. 500.00
Equipment (old)……………………………………11,000.00
Cash…………………………….…………………. 10,500.00
In the previous illustration, in which a loss was recognized, the new
asset was recorded at the purchase price of Br. 12000 and a loss of Br.
500 was recognized. If the transaction is for similar assets and is to be
recorded for income tax purpose, the loss should not be recognized. In
this case, the cost basis of the new asset will reflect the effect of the
unrecorded loss. The cost basis for the new asset, therefore, is
computed by adding the cash payment to the carrying value of the old
asset:
Carrying (Book) value of old
Equipment……………………..Birr 2,000.00
Cash paid (Boot given)………… 10,500.00
Cost-basis of new Equipment …… Birr 12,500.00
July 5. Equipment(New)…………….12,500.00
Accumulated Depreciation……… 9,000.00
Equipment (old)……………………………11,000.00

Cash……………………………………….. 10,500.00
To record exchange of Equipment's - cost of old Equipment's
and its related Accumulated Depreciation removed from the
accounts; new equipment recorded at amount equal to book
value of old equipment plus boot given.
Gain Recognized on the Exchange
 Gains on exchanges are recognized for financial reporting purposes when
dissimilar assets are exchanged. To illustrate the recognition of a gain,
assume the following terms in which the machines being exchanged serve
different functions:
Price of new machine………………………Birr 12,000.00 Trade-in
Allowance for old machine……………………..(3000)
Cash payment required (Boot given)……..….Birr 9,000.00
 Here the trade-in allowance (Br. 3000) exceeds the carrying value (Br.
2000) of the old machine by Br. 1000. thus, there is a gain on the
exchange, if the trade-in allowance represents the fair mark value of the
old machine. Assuming that this condition is true, the entry to record the
transaction is as follows:
July 5. Equipment (New)……………………12,000
Accumulated Depreciation………….9,000
Equipment (old)………………………………11,000
Cash …………………………………….……… 9,000
Gain on exchange of Equip………………..1,000
To record the exchange of Equipment's to remove cost of
old equipment and the related accumulated depreciation,
new equipment recorded at cost price; gain recognized.
Gain Not Recognized on the Exchange:
A gain on an exchange should not be recognized in the
accounting records if the assets perform similar functions. The
cost basis for the new equipment must indicate the effect of
the unrecorded gain. This cost basis is computed by adding the
cash payment to the carrying value of the old asset:
Carrying value of old equipment ……………..Birr 2,000.00
Cash paid (Boot Given)………………………… 9,000.00
Cost basis of new Equipment……………. Birr 11,000.00
July 5. Equipment (New)…………………..11,000.00
Accumulated Depreciation…………… 9,000.00
Equipment (old)…………………………………..11,000.00

Cash…………………………………………………9,000.00
To record exchange of Equipment to remove the cost of old
equipment and the related accum. depr. of old assets; new
equipment recorded at a cost equal to BV of old asset plus
cash paid.
 ACCOUNTING FOR INTANGIBLE ASSETS
 Intangible assets include patents, copyrights, trademarks, franchises, organization
costs, leaseholds, leasehold improvements, and goodwill. The allocation of
intangible assets to the periods they benefits is called amortization.
 Intangible assets are rights, privileges, and competitive advantages that result
from the ownership of long-lived assets that do not possess physical substance.
Evidence of intangibles may exist in the form of contracts or licenses. Intangibles
may arise from the following sources:
 1. Government grants, such as patents, copyrights, licenses, trademarks, and trade
names.
 2. Acquisition of another business, in which the purchase price includes a payment
for goodwill.
 3. Private monopolistic arrangements arising from contractual agreements, such as
franchises and leases.
Companies record intangible assets at cost. This cost consists of all
expenditures necessary for the company to acquire the right, privilege, or
competitive advantage. Intangibles are categorized as having either a limited
life or an indefinite life. If an intangible has a limited life, the company
allocates its cost over the asset’s useful life using a process similar to
depreciation.
The cost of intangible assets with indefinite lives should not be amortized.
To record amortization of an intangible asset, a company increases (debits)
Amortization Expense and decreases (credits) the specific intangible asset.
(Unlike depreciation, no contra account, such as Accumulated Amortization,
is usually used.) Intangible assets are typically amortized on a straight-line
basis. Companies classify amortization expense as an operating expense in
the income statement .
Patent
A patent is an exclusive right issued by a patent office that enables the
recipient to manufacture, sell, or otherwise control an invention for a
specified number of years from the date of the grant. These “legal lives”
sometimes vary across countries, but the legal life in many countries is
20 years. A patent is non-renewable. But, companies can extend the
legal life of a patent by obtaining new patents for improvements or
other changes in the basic design. The initial cost of a patent is the
cash or cash equivalent price paid to acquire the patent.
The patent holder amortizes the cost of a patent over its legal life or
its useful life, whichever is shorter.
To illustrate the computation of patent amortization, assume
that National Labs purchases a patent at a cost of NT$720,000.
If National estimates the useful life of the patent to be eight
years, the annual amortization expense is NT$90,000
(NT$720,000 ÷ 8). National records the annual amortization
as follows.
Dec. 31 Amortization Expense …………………90000
Patent ………………………………………….90000
Copyrights
Copyright is a legal right given to artists and authors to
publish and sell artistic or musical composition. The legal
life of copy right is creator’s life + 50 years (it extends 50
years beyond the artist/author’s death). Copy right can be
purchased from others. Because of the uncertainty
regarding the useful life of a copy right, the cost is
normally amortized over short period of time.
A trademarks or trade names is a word, phrase or symbol that identifies a
particular enterprise or product. Trade names like Starbucks, adidas, and
Coca-Cola create immediate product identification. They also generally
enhance the sale of the product. The creator or original user may obtain
exclusive legal right to the trademark or trade name by registering it with a
patent office or similar governmental agency. Such registration provides a
specified number of years of protection, which can vary by country but is
commonly 20 years. The registration may be renewed indefinitely as long
as the trademark or trade name is in use.
If a company purchases the trademark or trade name, its cost is the
purchase price. If a company develops and maintains the trademark or trade
name, any costs related to these activities are expensed as incurred. Because
trademarks and trade names have indefinite lives, they are not amortized.
Good will represents the value of all favorable attributes that
relate to a company that is not tied to any other specific asset.
These attributes include exceptional management, desirable
location, good customer relations, skilled employees, high-quality
products, and harmonious relations with labor unions. Goodwill
is unique. Unlike assets such as investments and plant assets,
which can be sold individually in the marketplace, goodwill can
be identified only with the business as a whole.
companies record goodwill only when an entire business is
purchased. In that case, goodwill is the excess of cost over the
fair value of the net assets (assets less liabilities) acquired.
Goodwill is not amortized because it is considered to
have an indefinite life, but its value should be written
down if impaired. Companies report goodwill in the
statement of financial position under intangible assets.
Natural resource consist of standing timber and underground
deposits of oil, gas, and minerals. These long-lived assets
have two characteristics that make them different from other
long-lived assets:
✓ they are physically extracted in operations such as mining,
cutting, or pumping; and
✓ Only an act of nature can replace them.
The allocation of the cost of natural resources in a rational and
systematic manner over the resource’s useful life is called
depletion (That is, depletion is to natural resources what
depreciation is to plant assets.)
Companies generally use the units-of-activity method
(discussed depreciation method) to compute depletion.
The reason is that depletion generally is a function of
the units extracted during the year.
There are three major steps we used to compute
depletion expenses are:
Step 1. Determine depletion base
Depletion base = Cost of resource- Residual Value
Step 2: Compute depletion rate.
Depletion Rate = Depletion base
Estimated Total Units of Resource
Step 3: Multiply the depletion rate by the quantity extracted from the
resource during the period.
i.e. Depletion expense = Depletion Rate * Quantity Extracted
To Illustrate, assume that Fox Lake Company invests $5.5 million in a
mine that is estimated to have 10 million tonnes (t) of uranium and a
$200,000 residual value. In the first year, 800,000 tonnes of uranium are
extract. Then calculate the depletion expense
Step 1. Depletion base = Cost of resource- Residual Value
$5,300,000 = $5,500,000-$200,000
Step 2. Depletion Rate = Depletion base
Estimated Total Units of Resource
$ 0.53 = $5,300,000/10,000,000
Step 3. Depletion expense = Depletion Rate * Quantity Extracted
$424,000 = $0.53*800,000
The calculated annual depletion expense is initially debited to an
inventory account, a current asset. Note that this is not the same
as depreciation for property, plant, and equipment, which is recorded
as an expense. Depletion of natural resources is accounted for
 in this way because the resource extracted is available for sale similar to
merchandise that has been purchased or manufactured for sale as we learned
in chapter 1.
Inventory ($0.53 × 800,000 t) 424000
Accumulated Depletion—Resource 424000
All costs of extracting the natural resource both current production costs
such as labour and depletion of the natural resource—are recorded as
inventory. When the resource is sold, the inventory costs, which include
depletion, are transferred to cost of goods sold and matched with the period’s
revenue. In other words, the depletion is charged to the income statement
only in the period in which the related goods are sold. Depletion related to
goods not yet sold remains in inventory and is reported as a current asset.
Quiz (5%)
Old vehicle
Vehicle cost $61,000
Vehicle acquisition date January 2, 2016
Estimated useful life 6 years
Estimated residual value $1,000
Depreciation method Straight-line
Fair value of old vehicle (asset given up) on October 1, 2021 $3,000
The list price of the new vehicle was $51,000. Chilko received an $8,000
trade-in allowance from the vehicle dealership for the old vehicle and paid
$43,000 cash ($51,000 − $8,000) for the new vehicle. Chilko’s year end is
December 31.
Chapter 2

The End

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